<PAGE>
As filed with the Securities and Exchange Commission on November 27, 2000
Registration No. 333-43396
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
----------------
X10 Wireless Technology, Inc.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
Delaware 3669 91-1989304
(State of or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of incorporation or Classification Code Number) Identification No.)
organization)
</TABLE>
15200 52nd Avenue South
Seattle, Washington 98188
(206) 241-3283
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
George E. Stevenson
Chairman of the Board and Chief Executive Officer
15200 52nd Avenue South
Seattle, Washington 98188
(206) 241-3283
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
----------------
Copies to:
<TABLE>
<S> <C>
Christopher W. Wright John M. Steel
Cydney S. Posner Mark F. Hoffman
Matthew D. Latimer Heidi M. Drivdahl
Eric Scott Carnell David F. Wickwire
Cooley Godward LLP Gray Cary Ware & Freidenrich LLP
5200 Carillon Point 999 Third Avenue, Suite 4000
Kirkland, Washington 98033-7355 Seattle, Washington 98104-4099
(425) 893-7700 (206) 839-4800
</TABLE>
----------------
Approximate date of commencement of proposed sale to the public:
As soon as practicable after the Registration Statement becomes effective.
----------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act,
check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_] ____________
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
number for the same offering. [_] ___________
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the
same offering. [_] ___________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
----------------
CALCULATION OF REGISTRATION FEE
<TABLE>
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<CAPTION>
Proposed Maximum
Title of Each Class of Proposed Maximum Aggregate Amount of
Securities Amount to be Offering Price Offering Registration
To be Registered Registered(1) Per Share(2) Amount(2) Fee(3)
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, $.001 par
value................. 5,750,000 $16.00 $92,000,000 $24,288
-------------------------------------------------------------------------------------
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</TABLE>
(1) Includes 750,000 shares which the underwriters have the option to purchase
to cover over-allotments, if any.
(2) Estimated solely for the purpose of calculating the registration fee in
accordance with Rule 457(a) and (o) under the Securities Act of 1933, as
amended.
(3) All of this amount has previously been paid.
----------------
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this
Registration Statement shall thereafter become effective in accordance with
Section 8(a) of the Securities Act of 1933, as amended, or until the
Registration Statement shall become effective on such date as the Commission,
acting pursuant to said Section 8(a), may determine.
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<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus is not complete and may be changed. We may +
+not sell these securities until the registration statement filed with the +
+Securities and Exchange Commission is effective. This prospectus is not an +
+offer to sell these securities, and it is not soliciting offers to buy these +
+securities in any state where the offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED NOVEMBER 27, 2000.
PRELIMINARY PROSPECTUS
[LOGO OF X10]
5,000,000 Shares
X10 Wireless Technology, Inc.
Common Stock
-----------
We are offering 5,000,000 shares of our common stock. This is our initial
public offering.
Our common stock has been approved for quotation on the Nasdaq National Market
under the symbol "XTEN." We estimate that the initial public offering price
will be between $14.00 and $16.00 per share.
See "Risk Factors" beginning on page 7 to read about certain risks that you
should consider before buying shares of our common stock.
Neither the Securities and Exchange Commission nor any other regulatory body
has approved or disapproved of these securities or passed upon the adequacy or
accuracy of this prospectus. Any representation to the contrary is a criminal
offense.
-----------
<TABLE>
<CAPTION>
Per
Share Total
----- ------
<S> <C> <C>
Public offering price............................................. $ $
Underwriting discounts and commissions............................ $ $
Proceeds, before expenses, to us.................................. $ $
</TABLE>
-----------
The underwriters may purchase up to an additional 750,000 shares of common
stock from us at the initial public offering price less the underwriting
discount, solely to cover over-allotments.
The underwriters expect to deliver the shares on or about , 2000.
-----------
Bear, Stearns & Co. Inc.
Prudential Volpe Technology
a unit of Prudential Securities
C.E. Unterberg, Towbin
The date of this prospectus is , 2000
<PAGE>
DESCRIPTION OF INSIDE FRONT COVER OF PROSPECTUS:
Top: In the left corner is the X10 Wireless Technology, Inc. logo. The inside
front cover is entitled "Wireless Distribution of Broadband Video and Audio
Content."
Middle: On the left is a two-dimensional image of the earth with the Americas
in the center. In front of the earth is an outline of a house, inside of which
is an image of a desk and chair and next to which is the word "Office." Behind
the earth and house is an outline of a house floorplan with the following words
designating various rooms in a house: "Family Room," "Living Room," "Office,"
"Master Bedroom," and "Den." A computer, monitor, keyboard and speakers are on
the desk together with an image of a wireless transceiver device. Entering from
the left side of the earth is an arrow from the earth labeled "Internet
Multimedia Content" pointing at the computer on the desk.
To the right of the earth and superimposed over the house floorplan under the
heading "Wireless Video Distribution" are images of a DVD player and a
television. Below the DVD player are the words "DVD Player." On top of the DVD
player is an image of an X10 transceiver device and in front of the television
is an image of an X10 wireless receiver device. A series of short, slightly
arched and parallel lines representing a wireless video signal run from the
transceiver to the receiver.
Under the heading "Wireless Audio Distribution" is an image of a pair of
speakers, in front of which is an image of an X10 wireless receiver device. A
series of short, slightly arched and parallel lines representing a wireless
audio signal run from the receiver to the transceiver located inside the house.
On the lower right half of the page and under the heading "Multimedia Content
Distribution," is an image of a television with the words "Internet Video
Stream" on its screen. In front of the television is an image of an X10 wireless
receiver device. A series of short, slightly arched and parallel lines
representing a wireless Internet video stream run from the receiver to the
transceiver located inside the house.
Bottom: On the left, next to the words "Our Wireless transceiver, receiver and
remote control, including related remote play software," are images of an X10
remote control, receiver, wireless transceiver and a screen shot depicting the
"Play" screen of the X10 Boom 2000 remote play software.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 7
Cautionary Note on Forward-Looking Statements............................ 23
Use of Proceeds.......................................................... 24
Dividend Policy.......................................................... 24
Capitalization........................................................... 25
Dilution................................................................. 26
Selected Financial Data.................................................. 27
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 28
Business................................................................. 37
Management............................................................... 52
Certain Transactions and Business Relationships.......................... 60
Principal Stockholders................................................... 64
Description of Capital Stock............................................. 65
Shares Eligible for Future Sale.......................................... 68
Underwriting............................................................. 70
Legal Matters............................................................ 72
Experts.................................................................. 72
Where You Can Find Additional Information................................ 72
Index to Financial Statements............................................ F-1
</TABLE>
----------------
Prospective investors may rely only on the information contained in this
prospectus. Neither X10 Wireless Technology, Inc. nor any underwriter has
authorized anyone to provide prospective investors with different or additional
information. This prospectus is not an offer to sell nor is it seeking an offer
to buy these securities in any jurisdiction where the offer or sale is not
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or any sale of these securities.
Until , 2000 (25 days after the date of this prospectus), all dealers
that effect transactions in these securities, whether or not participating in
this offering, may be required to deliver a prospectus. This is in addition to
the dealers' obligations to deliver a prospectus when acting as underwriters
and with respect to their unsold allotments or subscriptions.
----------------
X-10(R), X10(R) and our stylized logo are registered U.S. trademarks that we
license from X10 Ltd. EagleEye(TM), VideoSENDER(TM), DVD Anywhere(TM), Big
Picture(TM), Xcam(TM), Xcam2(TM), XRay Vision(TM), ScanCam(TM), MP3
Anywhere(TM), ActiveHome(TM), IR Commander(TM), Protector Plus(TM) and Monitor
Plus(TM) are trademarks we either own or license from X10 Ltd. All trademarks,
service marks and trade names of other companies appearing in this prospectus
are the property of their respective holders.
<PAGE>
(This page intentionally left blank.)
2
<PAGE>
PROSPECTUS SUMMARY
This summary contains basic information about us and this offering. Because
it is a summary, it does not contain all of the information that you should
consider before investing. You should read the entire prospectus carefully,
including the section entitled "Risk Factors" and our financial statements and
the related notes before making an investment decision.
X10 WIRELESS TECHNOLOGY, INC.
We offer affordable products that allow consumers to network devices,
systems and appliances within homes and small offices as well as remotely via
the Internet. These products are based on a variety of technologies, including
high-capacity, high-speed content delivery technologies, commonly referred to
as broadband, as well as other wireless, phoneline, electrical and infrared
technologies. We design, develop and market broadband wireless products that
enable users to receive and deliver video and audio content and to distribute
broadband Internet content from a personal computer, or PC, to televisions,
stereos and other electronic entertainment devices within a home or small
office. In addition, we offer networking products based on other technologies
that enable consumers to control security, lighting, heating and air
conditioning systems. All of these products can operate together to create a
home or small office network. Users can access and control these networking
products directly from a PC or through remote controls, wall-mounted panels,
telephones or the Internet. We sell these broadband wireless and control
products primarily through our website. In addition, we have recently commenced
sales of these products, indirectly through our affiliates, to sellers of
customized, bundled or private-label versions of these products and to
retailers, independent contractors and value-added resellers. We have incurred
operating and net losses since we commenced operations in July 1997, including
a net loss of $8.1 million for the nine months ended September 30, 2000, and we
expect to incur additional losses in the future. We have a limited operating
history, and, as of September 30, 2000, we had an accumulated deficit of $12.0
million.
In recent years, the increased availability of complex multimedia content,
coupled with the rapid growth in Internet use, has driven demand for broadband
access at home and in the workplace. According to International Data
Corporation, an independent research firm, installation of broadband access is
expected to increase from 2.1 million U.S. households in 1999 to 21.2 million
U.S. households in 2003. Within the home and small office environment, this
increasing demand for broadband access, together with the rapid growth in use
of PCs and entertainment devices, has fueled the need for home and small office
networks that enable communications among electronic and electrical systems
that are often centered around a PC. To address this need, a number of
companies have dedicated significant financial and technical resources to
developing different networking technologies. However, many currently available
networking products suffer from a number of constraints related to cost,
functionality and ease of use. We believe that these limitations create a
significant market opportunity for providers of affordable and effective home
and small office networking solutions.
Our technologies include wireless applications that operate in the 2.4 GHz
radio frequency band. We believe that our expertise in wireless technologies
and our customer-oriented approach to product development enable us to develop
cost-effective, high-quality products. We offer products as individual
components, allowing consumers to create customized networks, or in kits, each
of which provides an integrated hardware and software solution.
We believe that our solution offers the following advantages:
. We offer a broad array of products and applications that can operate
together and are compatible with most widely used home and small office
electronic and electrical systems, allowing consumers to network their
existing devices.
3
<PAGE>
. The products we offer employ multiple networking technologies, enabling
us to design products using the technologies best suited to achieve a
specific function.
. Our convenient wireless products allow consumers to network devices,
systems and appliances within homes and small offices, in most cases
without the need for additional telephone jacks, electrical outlets or
wiring.
. We offer consumers the opportunity to easily and affordably network
their homes and small offices by reducing the cost and complexity
typically associated with home and small office networking products and
technology.
Our strategy to provide affordable networking solutions for homes and small
businesses includes the following key elements:
. capitalize on our existing technologies to design, develop and market
products that extend our broadband and remote access capabilities;
. expand strategic relationships to extend our market reach;
. cross-sell additional control products to customers purchasing broadband
products;
. provide a compelling value proposition centered around high-performance
and affordability;
. capitalize on our relationship with X10 Ltd. and its affiliates;
. expand professional contractor relationships; and
. build our international presence.
Our Relationship with X10 Ltd. and its Affiliates
We were operated and financed for approximately two years as a division of
X-10 (USA) Inc., a wholly owned subsidiary of X10 Ltd. As a result, we have a
limited operating history as an independent entity. X10 Ltd. is a Bermuda
corporation based in Hong Kong which, together with its affiliates, designs and
manufactures home control and entertainment and security technology products.
Upon completion of this offering, X10 Ltd. and its controlling stockholders
will beneficially own approximately 64.1% of the outstanding shares of our
common stock and will be able to control the vote on most matters submitted to
our stockholders. X-10 (USA), based in New Jersey, provides sales, marketing
and product distribution services for X10 Ltd. in the U.S. Since we were
incorporated as a separate company in July 1999, we have continued to maintain
close business relationships with X10 Ltd. and its affiliates.
We have entered into agreements with X10 Ltd. under which it provides
manufacturing and product development services to us, licenses to us rights to
the X10 brand and markets our products to resellers. Similarly, we have entered
into agreements with X-10 (USA) under which it provides order fulfillment
services and sells X10-branded products to retailers and other resellers in the
western hemisphere. We seek to capitalize on these relationships with X10 Ltd.
and its affiliates to expand sales, reduce product costs, speed product
development, manage inventory and obtain fulfillment services.
4
<PAGE>
Corporate Information
We were incorporated in Delaware on July 29, 1999. Our principal executive
offices are located at 15200 52nd Avenue South, Seattle, Washington 98188. Our
telephone number is (206) 241-3283. Information contained on our website does
not constitute part of this prospectus.
THE OFFERING
<TABLE>
<C> <S>
Common stock being offered................. 5,000,000 shares
Common stock outstanding after this
offering.................................. 25,050,000 shares
Use of proceeds............................ We plan to use the net proceeds
of this offering for general
corporate purposes, including
sales and marketing, research and
development, capital expenditures
and working capital.
Proposed Nasdaq National Market symbol..... XTEN
</TABLE>
Common stock outstanding after this offering is based on the number of
shares outstanding as of September 30, 2000, excluding:
. 1,450,000 shares of common stock issuable upon exercise of stock options
outstanding as of September 30, 2000, at a weighted average exercise
price of $0.001 per share;
. 240,000 shares of common stock issuable upon exercise of stock options
to be granted at an exercise price equal to 70% of the initial public
offering price per share;
. 2,050,000 shares of common stock available for future grant of options
under our 1999 Stock Plan as of September 30, 2000, which plan will be
terminated effective upon completion of this offering; and
. 3,110,000 shares of common stock available for future issuance under our
2000 Equity Incentive Plan and our 2000 Employee Stock Purchase Plan.
Except as otherwise noted, all information in this prospectus assumes:
. no exercise of the underwriters' over-allotment option; and
. no exercise of outstanding stock options.
5
<PAGE>
SUMMARY FINANCIAL DATA
(in thousands, except per share data)
<TABLE>
<CAPTION>
Nine Months
July 1, 1997 Year Ended Ended
(inception) to December 31, September 30,
December 31, ---------------------- -----------------
1997 1998 1999 1999 2000
-------------- ------- ------------- ------- --------
(As restated,
see note 8)
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Net revenues............ $ 134 $ 2,997 $ 15,893 $ 9,941 $ 21,322
Gross profit............ 78 1,854 6,913 4,754 8,415
Total operating
expenses............... 349 3,685 14,264 8,210 16,575
Net loss................ (271) (1,831) (7,349) (3,456) (8,112)
Basic and diluted net
loss per common share.. $ (0.40)
========
Weighted average shares
used to compute basic
and diluted net loss
per common share....... 20,050
========
Pro forma basic and
diluted net loss per
common share........... $ (0.37)
========
Weighted average shares
used to compute pro
forma basic and diluted
net loss per common
share.................. 20,050
========
</TABLE>
See note 1 of notes to the financial statements for information concerning
the calculation of pro forma basic and diluted net loss per common share. The
information for the year ended December 31, 1999, is presented as restated. See
note 8 of notes to the financial statements.
The following table presents summary balance sheet data as of September 30,
2000, on an actual basis and as adjusted to reflect the application of the
estimated net proceeds of $67.8 million from the sale of 5,000,000 shares of
our common stock in this offering at an assumed initial public offering price
of $15.00 per share, after deducting estimated underwriting discounts and
commissions and estimated offering expenses.
<TABLE>
<CAPTION>
September 30, 2000
--------------------
Actual As Adjusted
------- -----------
<S> <C> <C>
Balance Sheet Data:
Cash and cash equivalents.................................. $ 2,323 $70,073
Working capital (deficit).................................. (9,496) 58,254
Total assets............................................... 5,226 72,976
Total stockholders' equity (net deficit)................... (7,849) 59,901
</TABLE>
We were operated and financed for approximately two years as a division of
X-10 (USA) Inc. We were incorporated as a separate company in July 1999. On
October 1, 1999, X10 Ltd. and X-10 (USA) contributed technology and other
intellectual property and net assets to us. Through September 30, 1999, our
summary statement of operations and balance sheet data are derived from the
historic books and records of X10 Ltd. and include cost allocations from X10
Ltd. and X-10 (USA).
6
<PAGE>
RISK FACTORS
An investment in our shares involves a high degree of risk. You should
consider carefully the following risks, in addition to the other information
presented in this prospectus, before purchasing our common stock.
Risks Related to Our Business
Our limited operating history makes forecasting future results difficult.
We have a very limited operating history, particularly with respect to those
aspects of our operations other than Internet sales. We began operations in
July 1997 as a division of X-10 (USA), a wholly owned subsidiary of X10 Ltd.,
to focus on establishing an Internet sales presence. On October 1, 1999, X10
Ltd. and X-10 (USA) contributed technology and other intellectual property and
net assets to us and, subsequently, we shifted our focus to designing,
developing and selling broadband wireless home and small office networking
products. The historical financial information contained in this prospectus
contains allocations between X-10 (USA) and us for administrative and other
expenses. These allocations may not be indicative of the levels of expenses
that would have resulted had we been operating as an independent, stand-alone
company or of future expense levels.
You must consider our limited operating history and prospects in light of
the uncertainties we may encounter due to our early stage of development,
including risks relating to:
. our relatively new and developing sales and marketing organization;
. the timing and extent of penetration into the market for sellers of
customized, bundled or private-label versions of the products we sell;
. our continued dependence on X10 Ltd. for manufacturing and other
services; and
. the recent emergence of the market for products related to broadband
technologies.
Also, you must consider our limited operating history in evaluating our ability
to:
. successfully execute our business and marketing strategy;
. expand and enhance our broadband wireless technology and product
offerings;
. further penetrate the market for home and small office networking
products;
. expand our distribution channels to sellers of customized, bundled or
private-label versions of the products we offer and to retailers,
independent contractors and value-added resellers; and
. develop strategic relationships independent of X10 Ltd.
We have a history of losses and we expect future losses. We cannot assure you
that we will achieve or maintain profitability.
We have incurred operating and net losses since we commenced operations in
July 1997. We expect to continue to incur net losses for the foreseeable
future, and we cannot assure you that we will ever be able to achieve or
sustain profitability. We incurred losses of $271,000 in 1997, $1.8 million in
1998, $7.3 million in 1999 and $8.1 million in the nine months ended September
30, 2000. As of September 30, 2000, we had an accumulated deficit of $12.0
million.
Historically, we have relied on X10 Ltd. to provide financing for our
operations; however, X10 Ltd. will not continue to be a source of liquidity for
us following this offering. In the future, we expect to incur significant
expenses for sales and marketing and research and development. We may not
generate a sufficient level of revenues to offset our expenditures or be able
to adjust spending in a timely manner to respond to any
7
<PAGE>
unanticipated decline or shortfall in revenue. If revenues grow more slowly
than we anticipate, if gross margins decline or if operating expenditures
exceed our expectations, we may continue to experience significant losses on a
quarterly and annual basis.
Our quarterly results of operations may vary significantly and may fail to meet
the expectations of securities analysts or investors, which may cause our stock
price to fluctuate.
Our quarterly results of operations have varied significantly in the past
and are likely to vary significantly in the future depending on a number of
factors, many of which are outside of our control. Accordingly, quarter-to-
quarter comparisons may not be indicative of future performance. Our results
may fall below the expectations of securities analysts or investors, and our
stock price may decline as a result of these fluctuations.
We expect to increase activities and spending in virtually all of our
operational areas. For example, we will seek to establish new reseller and
other strategic relationships, either indirectly through X10 Ltd. or directly,
which may expose us to sales cycle variability caused by potentially lengthy
evaluation, testing and acceptance procedures and reduce our liquidity due to
longer payment cycles. Significant delays or cancellations, especially with
respect to larger orders, arising from customer acceptance reviews, budgetary
constraints or otherwise could materially and adversely affect our quarterly
financial results, which may disappoint investors and cause our stock price to
decline significantly.
In addition, our quarterly results of operations may fluctuate as a result
of factors described below and elsewhere in the "Risk Factors" section of this
prospectus, including:
. the rate of market acceptance of the products we offer;
. seasonal fluctuations affecting our product sales, including
fluctuations due to the holiday season;
. changes in gross margin of our product offerings;
. the variability of our expenses;
. our ability to anticipate consumer demand for networking products for
homes and small offices;
. variations in the mix of products sold;
. the timing and effectiveness of promotions and sales programs; and
. general economic conditions, as well as economic conditions specific to
the home and small office networking markets.
We derive a substantial portion of our gross revenues from sales of kits
featuring a single product that may become obsolete or could be duplicated by
competitors.
In the first three quarters of 2000, 52.0% of our gross revenues from
Internet sales were derived from sales of kits that feature our wireless
cameras. Competitors may introduce products similar to ours, based on more
advanced technology, lower cost or additional features, including improved
speed and reliability, reduced product size and greater ease of installation
and use. If sales of these kits were to decline significantly, our revenues and
other results of operations would be materially harmed.
If we fail to expand existing indirect distribution channels, or to develop new
ones, our business could suffer.
From inception through September 30, 2000, we had $1.2 million in net
revenues from sales through X10 Ltd. to sellers of customized, bundled or
private-label versions of products and approximately $1.0 million in net
revenues from sales to retailers through X-10 (USA). Part of our strategy is to
expand these relationships indirectly through X10 Ltd., to increase sales of
the products we sell to retailers through X-10 (USA) and to independently
originate strategic relationships with original equipment manufacturers,
retailers, independent contractors and value-added resellers. If we fail to
expand our indirect and other reseller relationships or to
8
<PAGE>
develop and cultivate these strategic relationships independently, or if these
third parties are not successful in their sales efforts, our sales may
decrease, our operating results may suffer substantially and we would not be
able to execute our strategy effectively. In addition, many of our resellers
also offer products that compete with the products we sell. Furthermore, we
cannot assure you that third parties in other distribution channels with which
we, X10 Ltd. or X-10 (USA) enter into agreements will market products
effectively or continue to devote the resources necessary to provide us with
effective sales, marketing and technical support. If we were unable to
establish effective distribution channels, our ability to expand, to reach
additional customers and to increase our net revenues would be materially and
adversely affected.
If we fail to recruit a sufficient number of contractors to install the
products we offer, our strategy and results of operations could be adversely
affected.
If we or X-10 (USA) are unable to recruit and train a sufficient number of
independent contractors, we may not be able to achieve our objective of
developing a network of contractors to act as resellers and to provide
installation services for end users of the products we offer. As a result, our
ability to address the installation needs of a segment of our customers, as
well as our results of operations, could be materially and adversely affected.
If the technology and intellectual property we own or license were inadequately
protected, our business and reputation could be harmed and we could lose a
valuable asset.
The steps we take to protect the intellectual property rights that we own or
license may be inadequate. If we are unable to protect our intellectual
property, we may lose a valuable asset or become involved in costly litigation
to protect our rights. X10 Ltd. and X-10 (USA) have access to and knowledge of
nearly all of our trade secrets and confidential information and, under our
intercompany agreements with them, they are required to keep confidential only
written information that we specifically identify. As a result, it is possible
that X10 Ltd. and X-10 (USA) may use or disclose our confidential information
in ways that could harm us. In addition, of X10 Ltd.'s employees, only its
research and development engineers have executed confidentiality or invention
assignment agreements, which may significantly harm our ability to establish
and protect our intellectual property rights in the future.
There are seven pending U.S. patent applications relating to the technology
we own or license. It is possible that:
. these pending applications may not result in the issuance of any
patents;
. if issued, one or more of the patents could be challenged or become the
basis of an interference action, which could result in our loss of the
right to prevent others from exploiting the technology claimed in these
patents; and
. current and future competitors could devise new competitive technologies
that are not covered by the patent applications.
Direct, indirect or contributory intellectual property infringement or related
claims against us could be costly and time consuming to defend, divert
management attention, preclude sales of the products affected and reduce our
revenues.
Other parties may assert direct, indirect or contributory copyright,
trademark or other intellectual property infringement or contractual claims or
unfair competition claims against us, which could cause us to lose a valuable
asset, change our business practices and preclude our continued sale of those
products affected. The law in many of these areas is uncertain, and we cannot
predict whether third parties will assert claims of infringement against us or
whether our customers will operate our products in accordance with applicable
laws or agreements they may have. We are aware of a notice of a claim of
infringement received by X-10 (USA) alleging that the telephone responder
product we offer, used to remotely control home appliances via a
9
<PAGE>
powerline signal initiated through a telephone, infringes upon a third party's
patent related to touch-tone operated control devices. If we are forced to
defend against this or any other claims, whether or not they are meritorious or
are ultimately determined in our favor, we may face costly litigation and
diversion of management's attention. In the event of a dispute, we may have to
pay damages, develop non-infringing technology or enter into royalty or
licensing agreements. Royalty or licensing agreements, if required, may not be
available on terms acceptable to us, if at all. We currently have no issued
patents that we could use defensively in the event of any litigation against
us.
The markets in which we compete are subject to rapid technological change,
requiring us to continually design and introduce new products. If we do not
address these technological changes, our products will become obsolete,
impairing our ability to compete and adversely affecting our business.
The market for networking products for homes and small offices is
characterized by rapid technological developments, frequent enhancements to
existing products, new product introductions, changes in customer requirements
and evolving industry standards. To remain competitive, we need to introduce,
in a timely manner, products that incorporate or are compatible with these
emerging technological developments in our market. We may have only a limited
amount of time to penetrate certain markets, and we cannot assure you that we
will be successful in achieving widespread acceptance of our products before
competitors offer products and services similar or superior to our products.
Any delays in product introductions could materially and adversely affect our
ability to compete and our results of operations. In addition, when we announce
new products or product enhancements that have the potential to replace or
shorten the life cycle of our existing products, customers may defer purchasing
our products.
The market for home networking products is dependent in large part on
product compatibility, speed and reliability of audio/video and data
transmission, ease of installation and use, and product size and simplicity. To
remain competitive, we must develop or gain access to new technologies to
enhance product performance and functionality, regularly introduce new products
or upgrade existing products to ensure that the products we offer remain
competitive and do not become obsolete. If we do not address these
technological challenges, our product sales will decline and our business and
results of operations will be materially and adversely affected.
We may not successfully expand into foreign markets or generate sufficient
revenues abroad, which could impede our growth and harm our business.
To date, we have generated limited revenues from sales outside the U.S. As a
component of our business strategy, we intend to expand into foreign markets
either directly or through X10 Ltd. or its affiliates. Before we can enter any
new international market, we must conform our wireless products to the
requirements of the regulatory agency in that market comparable to the U.S.
Federal Communications Commission, which may impose significant burdens and
delay our international expansion plans. Our limited experience with
international expansion may accentuate risks we may encounter as we seek to
enter foreign markets, including:
. our ability to customize the products we offer for local markets and
foreign languages;
. foreign laws and business practices favoring local competitors;
. our dependence on local staff and vendors;
. compliance with multiple, conflicting and changing foreign governmental
laws and regulations, including communications, tax and import/export
laws and regulations;
. longer sales and collection cycles in overseas markets, particularly
with respect to sales to sellers of customized, bundled or private-label
versions of the products we offer;
. accounts receivable collection;
. currency exchange rate fluctuations;
. language barriers;
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. difficulties in enforcing contracts and other legal rights;
. economic and political instability; and
. uncertainty regarding protection and enforcement of intellectual
property rights.
If we are unable to successfully manage the risks associated with our
international operations, our business and prospects for growth could be
significantly harmed.
Manufacturing or design defects in the products we offer could harm our
reputation and have a material and adverse impact on our revenues and prospects
for growth.
Any defects or deficiencies in the products we offer could reduce the
functionality, effectiveness or marketability of these products, harm our
reputation and have a significant and adverse impact on our revenues and
prospects for growth. For example, some of the products we offer are connected
to electrical systems and, if defective, could pose electrical or fire hazards.
Product defects or deficiencies could cause orders to be canceled or delayed,
reduce our net revenues, render products obsolete or subject us to excessive
returns or product warranty or liability claims. In that event, we would be
required to devote substantial financial and other resources, for a significant
period of time, to designing, developing and manufacturing new products without
defects or deficiencies. We cannot assure you that we will be successful in
addressing any manufacturing or design defects or in designing and developing
new products in a timely manner, if at all.
Our manufacturer may experience shortages of supply of components for the
products we offer, which could involve substantial cost and delay and reduce
the availability of these products.
X10 Ltd., together with its affiliates, purchases some of the component
parts used to manufacture the products we offer, including the color image
sensors used in our wireless cameras, from single source vendors. Our
manufacturer's reliance on these single source vendors involves risks,
including the possibility of shortages of key component parts and reduced
control over delivery schedules, manufacturing capability, quality and costs.
In addition, some key components require long delivery times. In the past, we
have experienced delays because key component parts have been unavailable to
our manufacturer. If our manufacturer is unable to obtain components, then we
may need to reconfigure our products, which could involve substantial cost and
delay and limit availability of the products we offer. Any of these events
could cause us to lose product sales, materially and adversely affect our
results of operations and harm our business.
The average selling prices of products we offer may decrease, which may affect
our gross margin.
The average selling prices for products we offer may be lower than expected
as a result of competitive pricing pressures, promotional programs and
customers that negotiate price reductions in exchange for volume orders or
longer-term purchase commitments. We expect to experience pricing pressure in
the future and anticipate that the average selling prices and gross margins for
the products we offer will decrease over the product life cycles. We cannot
assure you that we will be successful in developing and introducing on a timely
basis new products with enhanced features that can be sold at higher gross
margins, nor can we assure you that we will be able to offset any future
declines in average selling prices with cost reductions.
We may have to reduce or cease operations if we are unable to obtain the
funding necessary to meet our working capital requirements.
X10 Ltd. will not be a continued source of liquidity for us following this
offering. In addition, to the extent that we are successful in increasing the
proportion of our net revenues derived from indirect distribution channels, our
accounts receivable may increase, and our cash flows and liquidity may be
adversely affected. If we are unable to generate sufficient cash flow from
operations or obtain funds through additional financing, we may have to reduce
some or all of our research and development and sales and marketing efforts or
cease operations. We believe that the net proceeds of this offering, together
with our available funds, will be
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sufficient to meet our capital requirements for at least the next 12 months.
However, if the net proceeds of this offering and our existing sources of cash
and cash flow are insufficient to support the expenses of our operations and
the expansion of our business, we may need to issue additional equity or debt
to finance our operations. If we issue additional stock to raise capital, your
percentage ownership will be reduced. Our funding requirements depend on
several factors, including the rate of market acceptance of the products we
offer, our ability to expand our customer base and the growth of our sales and
marketing capabilities. If our funding requirements vary from our current
plans, we may require additional financing sooner than we have anticipated.
Additional financing may not be available on terms favorable to us, if at all.
Our success depends on our retention of key personnel.
Our success depends to a significant degree upon the continued contributions
of our key management and engineering personnel, many of whom would be
difficult to replace. Our future success also depends on these personnel
effectively working together. If we lose the services of any of our key
personnel, especially the services of George Stevenson, chairman of our board
of directors and our chief executive officer, it may substantially harm our
business and results of operations. We do not have employment contracts with
any of our key personnel, and we maintain "key person" life insurance only on
James Phillips, our chief technology officer.
If we fail to recruit qualified engineering and technical personnel, new
product offerings could be delayed and our business could be harmed.
We devote, and will continue to devote, substantial resources to attracting
engineering and technical personnel. If we do not succeed in attracting new
personnel or retaining and motivating our current personnel, our business could
be materially harmed. Competition for qualified personnel is intense,
particularly in high-technology centers such as the Pacific Northwest. In
making employment decisions, particularly in high-technology industries, job
candidates often consider the value of stock options they may receive in
connection with their employment. If the value of our common stock decreases,
it could significantly impair our recruiting or retention efforts.
We have experienced significant growth in our business in recent periods, and
any inability to manage this growth and any future growth could harm our
business.
Our historical growth has placed, and any further growth likely will
continue to place, a significant strain on our management, operations,
administrative resources, software and systems. Any failure to manage our
growth effectively could damage our prospects, injure our reputation, cause us
to lose key personnel and otherwise significantly harm our business and results
of operations. To be successful, we will need to continue to implement
management information systems and improve our operating, administrative,
financial and accounting systems and controls. We also will need to train new
employees and maintain close coordination among our executive management,
operations, customer acquisition and retention and customer service
organizations. These processes are time consuming and expensive, increase
management responsibilities and divert management attention.
Our reliance on manufacturing in China exposes us to potential import
restrictions, duties or disruptions in trade.
All of the products we offer are manufactured and assembled for us by X10
Ltd. and its affiliates in China. As a result, our operations could be
materially and adversely affected by the disruption of trade with China or any
other foreign country where the products we offer may be manufactured in the
future. Also, these products may become subject to significant import duties,
tariffs or restrictions, which would adversely affect our business and results
of operations. Similarly, any adverse political, social or economic
developments in China or other foreign countries where these products may be
manufactured could materially and adversely affect our business and results of
operations.
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Failure to successfully promote and maintain the X10 brand could materially and
adversely affect our product sales and business.
Our ability to develop and maintain awareness of the X10 brand is important
in order to expand our sales and achieve widespread acceptance of the products
we offer. If we are unable to promote the X10 brand successfully, customer
awareness could decrease and sales of the products we offer could decline. Due
in part to the emerging nature of the home and small office networking market,
the substantial resources available to many of our competitors and our
competitors' existing brand recognition, we may have only a limited opportunity
to achieve and maintain a significant market share. The importance of brand
recognition will increase as competition in our market increases. Our ability
to successfully promote and maintain the X10 brand will depend on a number of
factors, including:
. the effectiveness of our sales and marketing efforts;
. our ability to continue offering high-quality, affordable products;
. the adequacy of our customer support and technical assistance;
. the reliability of independent contractor services;
. the use by X-10 (USA) of the X10 brand, which we have sublicensed to it
for sales to retailers of electrical products in the western hemisphere;
. the absence of product defects, safety issues or recalls; and
. the absence of any negative publicity related to the products we offer.
If our planned marketing efforts are ineffective, we may need to increase our
financial commitment to creating and maintaining brand awareness, which could
divert financial and management resources from other aspects of our business or
cause our operating expenses to increase disproportionately to our revenues.
We depend on third parties to pack and ship our customer orders. Any problems
with these third parties could materially impair our results of operations and
harm our reputation.
Currently, X-10 (USA) fulfills all of our Internet customer orders using
third-party shippers. Therefore, we are subject to the risk that labor
shortages, strikes, inclement weather or other factors may limit the ability of
these carriers to meet our shipping needs. Failure of the shippers selected by
X-10 (USA) to deliver products to our customers in a timely manner would damage
our reputation and could materially and adversely affect our operating results.
If these third-party shippers are unable or unwilling to deliver products to
our customers, X-10 (USA) would need to arrange for alternative carriers. X-10
(USA) may be unable to engage an alternative carrier on a timely basis or upon
terms favorable to us. X-10 (USA)'s third-party shippers may also increase the
charges for their shipping services. If our fulfillment agreement with X-10
(USA) is terminated, we may not be able to outsource our fulfillment needs on
terms favorable to us. Any increase in fulfillment costs would decrease our
operating margin and could materially and adversely affect our results of
operations.
There may be potential health and safety risks related to the products we offer
that could negatively affect our business and product sales.
The emission of electromagnetic radiation has been the subject of recent
public concern regarding possible health and safety risks. In addition, the
products we offer could pose potential electrical or fire hazards. Safety
issues relating to the products we offer may arise in the future, which could
materially and adversely affect our business, reputation and results of
operations.
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Risks Related to Our Industry
Our success depends in part on the continued growth of broadband access
services. If these services are not widely adopted, our sales will be adversely
affected.
Sales of our products depend on the increased use and widespread adoption of
broadband access services, such as cable, satellite, and other high-capacity
communication links. These broadband access services typically are more
expensive in terms of required equipment and on-going access charges than the
services of dial-up Internet access providers. If the market for broadband
access services does not grow as anticipated, demand for our broadband wireless
products will decline and our business and results of operations will be
materially and adversely affected.
The market for home and small office networking products is in an early stage
of development, and the products we offer may not achieve widespread
acceptance.
Our success will depend substantially upon the widespread demand for and
acceptance of home and small office networking products. If this market does
not continue to grow, the products we offer may not achieve widespread
acceptance and our business and results of operations could be significantly
harmed. Demand for recently introduced products and technologies, especially in
the broadband wireless market, is subject to a high level of uncertainty.
Factors that may affect widespread acceptance of the products we offer include:
. the level of consumer awareness of home and small office networking
technologies;
. the rate of consumer adoption of broadband access and content;
. the complexity of product installation and maintenance;
. the rate of adoption of standardized technology, especially in the
wireless technology field, which may cause consumer hesitation and
concerns over long-term product compatibility and viability; and
. the rate of data throughput, which may affect the quality of audio/video
transmissions over the Internet.
As a result, we cannot accurately predict the future growth rate or ultimate
size of the networking market for homes and small offices.
Emerging industry standards may reduce the demand for our products, which will
materially harm our business.
Increased acceptance of new industry standards, whether through adoption by
official standards committees or widespread use by consumers, could require us
to redesign our products to remain competitive. Home networking products
operating in the 2.4 GHz radio frequency band and based on various standards,
some of which are faster than our products, are available from other companies.
There are also companies developing products based on standards for the faster
5 GHz radio frequency band. Protocols or de facto standards, such as Bluetooth,
are also gaining increased acceptance. Widespread adoption of these or other
standards and protocols increases the risk that our products, which do not
conform to these standards or protocols, may become obsolete or incompatible
with products based on these standards or protocols. Noncompliance with these
standards or protocols could deter potential customers from purchasing our
products. Any failure by us to develop and introduce new products or
enhancements based on widely adopted industry standards could materially harm
our business, competitive position and results of operations.
If we are unable to compete successfully against current and future
competitors, our ability to expand our business or even to maintain revenues at
current levels, will be materially harmed.
The networking market for homes and small offices is relatively new, rapidly
evolving and intensely competitive, and we expect competition to intensify in
the future. Increased competition may force us to reduce
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prices, which would result in reduced gross margins and cause us to lose market
share, any of which could materially harm the growth of our business and our
results of operations. In addition, the relatively low barriers to entry in the
home and small office networking markets could attract additional market
entrants, many of which may have greater resources than we have or may be able
to achieve greater cost efficiencies than we can.
We currently or potentially compete with a variety of other companies,
including providers of networking infrastructure for homes and small offices
and companies providing entertainment-oriented broadband communications
products. In addition, many of our competitors have longer operating histories,
larger customer bases, greater brand recognition and significantly greater
financial, technical, marketing and other resources than we have. Many of these
competitors may also be better able to take advantage of customer, reseller,
supplier and other relationships. Furthermore, large, well-established or well-
financed entities may join with our competitors, or other companies, to produce
home and small office networking products superior to or more cost-effective
than those we offer.
Compliance with Federal Communications Commission, or FCC, and foreign
regulations is costly, and regulations are constantly changing.
The FCC requires that our wireless products be certified and imposes a
number of restrictions on our use of radio frequencies, which could interfere
with the operation, or prevent the sale, of our products. We cannot assure you
that we will be able to secure certifications required by the FCC, for the
products that we intend to deploy in 2000 and thereafter. The need to obtain
these certifications could result in delays or additional costs. In addition,
the changing regulatory environment could adversely affect the nature and
extent of products we are able to offer by rendering current products obsolete,
restricting the applications and markets served by our products or increasing
the opportunity for additional competition. We may desire or, as a result of
changes in regulations, be required to seek to operate in other frequency
bands. Redesigning our products to operate in other frequency bands would be
costly and time-consuming, and we cannot assure you that any redesigned
products would receive certifications required by the FCC or would be
commercially viable.
Our wireless products share the 2.4 GHz radio frequency band with other
users. This frequency band does not require a license from the FCC. In the
event that there is interference between priority users and us, those users can
require that we curtail transmissions that create interference. Similarly, as a
non-priority user, we must accept any interference present in the frequency
band. If users of our products experience excessive interference from licensed
users or other non-priority users, market acceptance of our products could be
adversely affected, which could materially and adversely affect our business
and results of operations.
Our products are also subject to regulatory requirements in international
markets. We must monitor the development of radio frequency regulations in
countries that represent potential markets for our products. Changes in, or our
failure to comply with, applicable international regulations could materially
and adversely affect our ability to expand internationally, as well as our
business and results of operations.
Risks Related to Our Dependence on X10 Ltd. and its Affiliates
The rights of our stockholders could be adversely affected because we are
controlled by X10 Ltd. and its stockholders.
X10 Ltd. and its controlling stockholders have, and upon completion of this
offering will continue to have, the ability to control most matters requiring
the vote of our stockholders, including the election of our directors and our
corporate actions. Upon completion of this offering, X10 Ltd. and its
controlling stockholders will beneficially own approximately 64.1% of the
outstanding shares of our common stock, including 52.2% beneficially owned by
George Stevenson, X10 Ltd.'s president, and 51.9% beneficially owned by
Hin Chew Chung, X10 Ltd.'s chairman. This concentration of ownership and other
rights could result in conflicts of interest between these stockholders and us,
impede our business development through loss of corporate opportunities or
otherwise, or delay or deter others from initiating a potential merger,
takeover or
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other change in control, even if these events would benefit our stockholders
and us. This concentration of ownership also could depress the market price of
our common stock.
We depend on X10 Ltd., X-10 (USA) and other affiliates of X10 Ltd. to provide
substantially all of our manufacturing and fulfillment services, to sell and
distribute products to retailers and other resellers and to provide product
development services.
We have entered into a series of intercompany agreements with X10 Ltd. and
X-10 (USA) relating to intellectual property rights, manufacturing, product
development, order fulfillment and sales and distribution to retailers and
other resellers. If any of these agreements were to terminate, our ability to
manufacture the products we offer, fulfill customer orders, expand our sales
and efficiently perform some aspects of our product development process would
be impaired, product production and delivery would be delayed, our net revenues
would decrease and our costs of operations would increase. Any of these events
would have a material adverse effect on our business and results of operations.
In addition, if any of these agreements were terminated, we may not be able to
enter into agreements with other third parties on a timely basis or on terms
favorable to us, or at all. As a result, our margins may be reduced and our
business could be substantially harmed. Currently, we outsource all of our
manufacturing and some of our research and development services to X10 Ltd. and
its affiliates, and they also market our products to retailers and other
resellers. Similarly, X-10 (USA) is our sole third-party provider of order
fulfillment services and sells X10-branded products to retailers. In general,
our only remedy specified under these agreements for breach or default by X10
Ltd. or its affiliates is termination of the agreements.
Our agreements with X10 Ltd. and X-10 (USA) were not the result of arm's
length negotiations and could subject us to less favorable terms than we
otherwise could have obtained from other third parties.
We have entered into a series of agreements with X10 Ltd. and X-10 (USA),
regarding licenses and assignments of technology and products, research and
development, product supply, manufacturing, sales and order fulfillment. These
agreements may contain or result in terms less favorable to us than we
otherwise could have obtained from other third parties. Because X10 Ltd. and X-
10 (USA) are controlled by George Stevenson, our chief executive officer and
chairman of our board, and Hin Chew Chung, one of our directors, these
agreements were not the result of arm's length negotiations.
We depend on X10 Ltd. and its affiliates to manufacture the products we offer,
and if X10 Ltd. did not have adequate manufacturing capacity, we may be unable
to meet production goals or satisfy customer requirements and our business and
results of operations would be materially and adversely affected.
X10 Ltd., together with its affiliates, is currently the sole manufacturer
of our products and has limited excess manufacturing capacity. If X10 Ltd. and
its affiliates:
. do not have adequate capacity at their existing facility to manufacture
products for us on a timely basis;
. experience operational, production or quality assurance difficulties; or
. experience a catastrophic event at X10 Ltd.'s manufacturing facility,
we could suffer a reduction or disruption of manufacturing services provided to
us and may be required to seek an alternate manufacturer. We cannot assure you
that we would be able to secure alternative manufacturing services on favorable
terms or a timely basis, if at all. In addition, using alternative
manufacturers could require us to reconfigure our products or otherwise involve
significant delays in product production and delivery or result in quality
control problems.
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We depend on X10 Ltd. and X-10 (USA) to sell and deliver the products we
offer to retailers and other resellers. If they fail to do so effectively,
our access to these customers would decrease, and it could significantly harm
our business.
Currently, X10 Ltd. and X-10 (USA) are our virtually exclusive sources of
access to retailers and other resellers. As a result, substantially all of the
products that we sell to retailers and other resellers are offered through
either X10 Ltd. or X-10 (USA). If either X10 Ltd. or X-10 (USA) were unable to
maintain its existing customer relationships or to develop new customer
relationships, our access to retailers and other resellers would decrease and
our business would be significantly harmed.
We depend on X10 Ltd. and its affiliates to provide a portion of our product
development activities. If they fail to perform these tasks adequately, it
could delay our introduction of new or updated products or result in the
production of inferior products, either of which could harm our business.
X10 Ltd. and its affiliates provide a portion of our product development
activities under the terms of a research and development agreement. If X10
Ltd. or its affiliates fail to perform the services X10 Ltd. has agreed to
provide, it could delay or prevent the introduction of products by us or
result in the production of inferior products, either of which could
materially harm our business. We cannot assure you that they will complete
their research and development services on a timely or cost-effective basis or
that, upon completion, the ultimate design of the requested products will meet
our specifications. Also, if X10 Ltd. or its affiliates lose key engineering
personnel, they may not be able to provide the services required under the
agreement, and our research and development initiatives could be materially
and adversely affected.
Our dependence on X10 Ltd. and its affiliates for product development
services may result in a loss of our proprietary rights if X10 Ltd. fails to
adequately protect our intellectual property and confidential information.
We depend on X10 Ltd. and its affiliates for mechanical engineering,
electronic layout and development of prototypes of our products, and X10 Ltd.
and its affiliates have access to our confidential information relating to the
designs and software incorporated into the products we offer. X10 Ltd. and its
affiliates have only limited confidentiality obligations to us, and we cannot
assure you that they will be able to protect our intellectual property rights
and confidential information from disclosures by their employees or other
third parties or to prevent the use of our confidential information in ways
that could substantially harm us. X10 Ltd. and its affiliates have entered
into written proprietary information and inventions agreements with only a few
of their employees and none with other third parties.
We depend on X-10 (USA) to fulfill all of our Internet customer orders, and
any problems with order fulfillment could impair our operating results and
harm our reputation.
We rely on X-10 (USA) to fulfill all of our Internet customer orders. We
cannot assure you that X-10 (USA) will fill customers' orders accurately or
that orders will be shipped on a timely basis and in appropriate packaging to
minimize damage to products. We generally bear all costs associated with lost
or damaged shipments. In addition, inaccurate, delayed or damaged shipments
could materially and adversely affect our reputation and business. If our
existing fulfillment arrangement were to be terminated, our business could be
disrupted, and we could incur costs and delays in making alternative
arrangements.
We depend on X10 Ltd. and its affiliates for inventory management, and any
failure to manage the inventory effectively could cause inventory to be
unavailable for shipments to customers.
We have entered into a product supply agreement with X10 Ltd. under which
X10 Ltd. and its affiliates manufacture all of the products we offer and ship
them to X-10 (USA), which acts as warehousing and consignment agent until we
take title to the products. Any failure of X10 Ltd. to maintain sufficient
inventory to meet our needs could cause inventory to be unavailable for
shipments to customers when requested, which could materially and adversely
impact our business and results of operations.
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We depend on X-10 (USA) to recruit and train independent contractors to
install the products we offer and, if these contractors are inadequately
trained or otherwise fail to perform, our ability to implement our strategy
and our results of operations could be materially and adversely affected.
We depend on X-10 (USA) to recruit contractors to act as resellers and to
train them to install the products we offer. If X-10 (USA) provides inadequate
training or if the contractors otherwise perform inadequately, customers could
be dissatisfied, we could receive customer complaints and our business and
results of operations could be materially and adversely affected. We currently
do not have a written agreement with X-10 (USA) to recruit or train these
contractors. If X-10 (USA) were to cease providing these services to us, we
may be unable to develop and implement similar recruitment and training
programs in a timely manner, which could result in our losing participants in
our contractor program and, ultimately, the loss of product sales.
Orca Monitoring Services, L.L.C., our affiliate, provides monitoring services
for the products we offer and if Orca fails to respond, we may have exposure
to claims for liability from customers.
We refer customers to Orca Monitoring Services, an affiliate of X10 Ltd.
based in Seattle, Washington, to perform the monitoring services in connection
with the monitored home security systems we offer. If Orca fails to respond to
an alarm signal or otherwise to perform its duties, we may face potential
claims from customers, which could have a material adverse effect on our
business and results of operations. In addition, our general liability
insurance policy contains a coverage exclusion for claims relating to
monitoring of home security systems.
Some of the key management personnel on whom we depend are also management
personnel or employees of X10 Ltd. or its affiliates, which could create
conflicts of interest between X10 Ltd. or its affiliates and us.
Our chief executive officer, George Stevenson, is also the founder,
president and a director of X10 Ltd. and is not our employee. Mr. Stevenson's
positions at X10 Ltd. could create real or apparent conflicts of interest in
the event that Mr. Stevenson were faced with decisions that could have
different implications for X10 Ltd. and us. These decisions may relate to
corporate opportunities, corporate strategies, potential acquisitions of
businesses, the intercompany agreements, competition, the issuance or
disposition of securities, the election of new or additional directors and
other matters. Our conflict of interest policy may not address all conflicts
that may arise, and, in any event, it is possible that conflicts may be
resolved in a manner adverse to us. Mr. Stevenson will spend a substantial
part of his professional time and effort on behalf of X10 Ltd. In many
instances, these efforts on behalf of X10 Ltd. will involve activities that
are unrelated, and in some circumstances may be adverse, to our interests. We
have not established any minimum time that Mr. Stevenson will be required to
spend on our behalf. In addition, Hin Chew Chung, one of our directors, is
also chairman of X10 Ltd. Furthermore, James Phillips, our chief technology
officer and one of our directors, is an employee of X-10 (USA) and works for
us on a full-time consulting basis. We cannot assure you that the information
Mr. Phillips learns in his capacity as our chief technology officer will be
kept confidential from X-10 (USA).
We could face potential competition from X10 Ltd, which could limit our access
to sales channels, our ability to pursue business opportunities and our
ability to compete effectively.
X10 Ltd. competes with us indirectly through its resellers. X10 Ltd.
currently has the right to sell products that do not bear the X10 brand and
are not based on broadband wireless technology worldwide. In addition, with
our consent, X10 Ltd. may sell our wireless products. Because we will be
selling the same or similar products, we will need to distinguish our product
offerings and price points from those offered by X10 Ltd. If we fail to do so,
we may not be able to access these sales channels in a meaningful way, and our
business could be significantly harmed. As a result of our various agreements
with X10 Ltd. and X-10 (USA), X10 Ltd. and X-10 (USA) will have access to
confidential information relating to our business, technology and products.
They could use any of this confidential information in a manner that gives
them a competitive advantage.
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We do not currently have a policy in place that governs the pursuit or
allocation of business opportunities between us and X10 Ltd. and its
affiliates, except to the extent that the intercompany agreements with X10 Ltd.
and X-10 (USA) restrict X10 Ltd. and its affiliates from selling broadband
wireless products without our consent. Our ability to take advantage of a
specific business opportunity may be affected by X10 Ltd.'s representation on
our board and voting control, as well as our relatively limited resources. As a
result, we may be unable to successfully pursue business opportunities
available to X10 Ltd. and us.
Risks Related to the Internet
Online security risks could seriously harm our retail operations and business
by reducing consumer willingness to purchase our products over the Internet and
by creating potential liability.
In 1999, approximately 98% of our net revenues were derived from sales
conducted over the Internet. The success of our online commerce business
depends, in large part, on consumers' confidence in the privacy of their
activities and the secure transmission of their confidential information.
If third parties were able to penetrate our network security or otherwise
misappropriate users' personal or credit card information, we could be subject
to liability. Our liability could include claims for unauthorized purchases
with credit card information, impersonation or other similar fraud claims as
well as for other misuses of personal information, such as for unauthorized
marketing purposes. These claims could result in costly and time-consuming
litigation, which could injure our reputation and materially and adversely
affect our business and results of operations.
In addition, anyone who is able to circumvent our security measures could
cause interruptions in our online retail operations. Recently, several well-
known websites were targeted by unauthorized persons and experienced short-term
disruptions in service. We cannot assure you we will be able to prevent similar
disruptions of service, which could distract managements' attention and
significantly harm our business.
Our long-term success depends on the development of the Internet and e-
commerce, which is uncertain.
We rely heavily on the Internet for most of our sales. If the use of the
Internet does not continue to grow, or grows at a slower rate than we
anticipate, or if the necessary Internet infrastructure or complementary
services are not developed to support effectively the growth that may occur,
our growth prospects and business could be significantly harmed. The
development of the Internet as a viable commercial marketplace is subject to a
number of risks, including whether potential customers are willing to shift
their purchasing from traditional vendors to online vendors and whether the
telecommunications infrastructure is adequate to support the Internet as an
effective commerce medium. In addition, the increased use of the Internet as a
medium for commerce raises concerns about Internet reliability, pricing,
accessibility and quality of service.
If we cannot protect our domain names, our ability to successfully build our
brand will be impaired.
We may be unable to acquire or maintain web domain names relating to the X10
brand in the U.S. and other countries in which we may conduct business. As a
result, we may be unable to prevent third parties from acquiring and using
domain names related to the X10 brand. Unauthorized use could damage the X10
brand and our reputation and divert customers from our websites. The
acquisition and maintenance of domain names generally is regulated by Internet
regulatory bodies. Governing bodies may establish additional top-level domains,
appoint additional domain name registrars or modify the requirements for
holding domain names. If we cannot prevent others from using similar domain
names, we may be unable to successfully protect the X10 brand, which could
cause us to lose a valuable asset and materially and adversely affect our
business. Furthermore, the relationship between regulations governing domain
names and laws protecting trademarks and similar proprietary rights is unclear.
Therefore, we may be unable to prevent third parties from acquiring domain
names that are similar to, infringe upon or otherwise decrease the value of our
owned or licensed trademarks and other intellectual property.
19
<PAGE>
Our facilities and systems are vulnerable to natural disasters and other
unexpected problems, and the occurrence of a natural disaster or other
unexpected problem could damage our reputation and the X10 brand and adversely
affect our results of operations.
Substantially all of our computer, communications and information systems as
well as our administrative offices are housed in Seattle, Washington, a
geographic area that is prone to earthquakes. The occurrence of an earthquake,
fire, flood, volcanic eruption or other natural disaster or unanticipated
problems such as power loss, telecommunications failure or break-in at our
headquarters could cause interruptions or delays in our business, result in
loss of data or render us unable to accept and fulfill customer orders. We do
not currently have a backup system or a formal disaster recovery plan in place.
Our business interruption insurance may not adequately compensate us for losses
that may occur. In addition, the failure to maintain the data communications
capacity required by us, as a result of human error, natural disaster or other
operational disruptions, could result in interruptions in our service. The
occurrence of any or all of these events could damage our reputation and brand
and materially impair our business.
If we become subject to additional burdens associated with government
regulation of the Internet, our retail sales may decline and our business may
be adversely affected.
Any new legislation could hinder the growth in use of the Internet and other
online services generally and decrease the acceptance of the Internet and other
online services as media of commerce. Laws and regulations directly applicable
to Internet communications, commerce and advertising are becoming more
prevalent. Laws and regulations may be adopted covering issues such as user
privacy, pricing, content and quality of products and services. The laws
governing the Internet are largely unsettled, even in areas where legislation
has been enacted.
The growth and development of e-commerce may prompt calls for more stringent
consumer protection and privacy laws, both in the U.S. and abroad, which may
impose additional burdens on companies conducting business online. For example,
the Federal Trade Commission and state agencies have been investigating various
Internet companies regarding their use of personal information. In addition,
the European Union Directive on the Protection of Personal Data may affect our
ability to expand into Europe if we do not afford adequate privacy to end users
of our sites. We could incur additional expenses or otherwise lose our ability
to expand our database if new regulations regarding the use of personal
information are introduced or if our privacy practices are investigated. We do
not currently have insurance to cover this type of loss. The adoption or
modification of laws or regulations relating to the Internet and other online
services could impose additional burdens on management, increase our expenses
and materially and adversely affect our business.
We may be liable for sales and other taxes that could increase the cost to
consumers of the products we offer and materially harm our results of
operations.
Tax authorities in many states are reviewing the appropriate tax treatment
of Internet and catalog retail companies. Any resulting state tax regulations
could subject us to the assessment of sales and income taxes in other states,
which could increase the cost to consumers of the products we offer and
materially harm our results of operations. We currently collect sales or other
similar taxes on goods shipped to addresses only in the states of Washington
and Nevada, which currently account for a relatively small percentage of our
net revenues. Since our products are available over the Internet in multiple
states and in foreign countries, these jurisdictions may require us to qualify
to do business. If we fail to qualify in a jurisdiction that requires us to do
so, we could face expenditures for taxes and penalties.
The U.S. Congress has enacted legislation, known as the Internet Tax Freedom
Act, limiting the ability of the states to impose taxes on Internet-based
transactions. However, this legislation imposes only a three-year moratorium,
which commenced October 1, 1998 and ends on October 21, 2001. The moratorium
restricts state and local taxes on e-commerce that are discriminatory against
Internet access, unless these taxes were generally imposed and actually
enforced prior to October 1, 1998. The U.S. House of Representatives has
approved an
20
<PAGE>
extension of the moratorium to 2006; however, the U.S. Senate has not yet voted
on the bill. It is possible that the tax moratorium could fail to be renewed
prior to October 21, 2001. Failure to renew this legislation would allow
various states to impose taxes on Internet-based commerce. The imposition of
these taxes could deter customers from purchasing over the Internet, cause our
sales to decline and materially harm our business and results of operations.
In addition, it is possible that the Internal Revenue Service or another
jurisdiction may seek to impose a sales, use or other tax based on our
relationship with X10 Ltd. in any jurisdiction in which X10 Ltd. maintains
operations. We cannot be certain that we would be successful in any challenge
to the imposition of sales or use tax.
We could face liability for publishing or distributing content, and our
business and results of operations could suffer if costs resulting from these
claims are not covered by our insurance or exceed our policy limits.
Our website currently contains a referral database of independent
contractors that includes ratings based on customer feedback. We also publish
other content on our website. We may be considered a publisher or distributor
of both our own and third-party content, and parties may download or copy
material from our website and distribute it to others. These parties may bring
claims against us for defamation, negligence, copyright or trademark
infringement, invasion of privacy and publicity, unfair competition or other
theories based on the nature and content of this material. Our general
liability insurance may not cover claims of this type or may not adequately
cover the costs we could incur in defending potential claims. Our business and
results of operations could suffer significantly if costs resulting from these
potential claims are not covered by our insurance or exceed our policy limits.
Risks Related to our Capital Structure and this Offering
Our management has broad discretion as to how to use the net proceeds of this
offering, and the proceeds may be put to uses that do not improve our results
of operations or increase our market value.
Our management will have considerable discretion in the application of the
net proceeds of this offering, and you will not have the opportunity, as part
of your initial investment decision, to assess whether the proceeds are being
used appropriately. The net proceeds of this offering may be used for corporate
purposes that do not improve our results of operations or increase our market
value. We have no specific plan as to how we will spend the net proceeds of
this offering. Pending application of the net proceeds, they may be placed in
investments that do not produce income or that lose value.
Provisions of our amended and restated certificate of incorporation and bylaws
could delay, deter or prevent a third party from acquiring us even if doing so
would be beneficial to our stockholders.
Provisions of our amended and restated certificate of incorporation and
bylaws may delay, deter or prevent a change of control, which could adversely
affect the market price of our common stock. These provisions include the
following:
. our board of directors is divided into three classes with staggered
three-year terms;
. our stockholders may not take action by written consent;
. our stockholders may not call special meetings and must comply with
advance notice provisions in order to submit proposals or nominations
for consideration at meetings of stockholders; and
. amendments to specific provisions of our amended and restated
certificate of incorporation and amended and restated bylaws require the
approval of holders of at least 66 2/3% of the voting power of all
outstanding shares.
21
<PAGE>
In addition, under our amended and restated certificate, our board of
directors will have the authority to issue up to 30,000,000 shares of preferred
stock and to determine the price, rights, preferences, privileges and
restrictions, including voting rights, of those shares without any further vote
or action by our stockholders. The rights of the holders of our common stock
will be subject to, and may be adversely affected by, the rights of holders of
any preferred stock that we may issue in the future. Our issuance of preferred
stock may delay, deter or prevent a change in control because the terms of the
preferred stock we could issue could have superior voting or other rights that
may be used to prevent a merger, reorganization, sale of substantially all of
our assets, liquidation or other extraordinary corporate transaction without
the approval of the holders of outstanding shares of common stock. Although we
currently have no plans to issue preferred stock, our issuance of preferred
stock could have a dilutive effect on our existing stockholders.
In addition, we are subject to the anti-takeover provisions of Section 203
of the Delaware General Corporation Law, which will prohibit us from engaging
in a "business combination" with an "interested stockholder" for a period of
three years after the date of the transaction in which the person became an
interested stockholder, unless the business combination is approved in a
prescribed manner.
Also, the laws of the state of Washington, where our principal executive
offices are located, impose restrictions on some transactions between a foreign
corporation and its significant stockholders. Chapter 23B.19 of the Washington
Business Corporation Act prohibits a "target corporation," with some
exceptions, from engaging in particular significant business transactions with
an "acquiring person," which is defined as a person or group of persons that
beneficially owns 10% or more of the voting securities of the target
corporation for a period of five years after the acquiring person's acquisition
of securities, unless a majority of the members of the target corporation's
board of directors approves the transaction or acquisition of shares before its
completion.
The provisions described above could have the effect of delaying,
discouraging or preventing changes in control or other transactions that could
involve premium stock prices or other benefits to our stockholders. These
provisions could discourage a proxy contest or otherwise make it more difficult
to change our management.
The price of our common stock may be volatile, which could subject us to
litigation.
Prior to this offering, there has been no public market for our common
stock. In addition, historically, we have been relatively closely held, with
X10 Ltd. and its controlling stockholders beneficially owning a majority of our
shares. If X10 Ltd. and its controlling stockholders continue to hold this
majority, the level of our public float may be limited, and an active public
market for our common stock may not develop or be sustained after the offering.
The initial public offering price will be determined by negotiations between us
and the representatives of the underwriters. The market price of our common
stock may decline below the initial public offering price after this offering.
Fluctuations in market price and volume are particularly common among
securities of high technology companies, including companies that provide home
and small office networking solutions or engage in e-commerce. The market price
of our common stock may fluctuate significantly in response to a number of
factors, including changes in market valuations of home and small office
networking and e-commerce companies, and other factors described elsewhere in
the "Risk Factors" section of this prospectus.
In addition, stock markets and exchanges and, in particular, The Nasdaq
Stock Market have recently experienced extreme price and volume fluctuations,
which have particularly affected the market prices of many technology and e-
commerce companies and which have often been unrelated to the operating
performance of these companies.
In the past, securities class action litigation has often been brought
against companies following periods of volatility in the market price of their
common stock. We may be the target of similar litigation. Securities litigation
could result in substantial costs and divert management's time and attention.
22
<PAGE>
Future sales of our common stock may negatively affect our stock price.
All of the shares sold by us in this offering will be freely tradable.
Following this offering, all of the other outstanding shares of our common
stock will be available for resale beginning at various points in time in the
future. The market price of our common stock could decline as a result of sales
of a large number of shares of our common stock in the market following this
offering or as a result of the perception that these sales could occur. These
sales also might make it more difficult for us to sell equity securities in the
future at a time and at a price that we deem appropriate. Our directors,
executive officers and other stockholders have agreed not to dispose of any
shares of common stock, subject to limited exceptions, for a period of 180 days
after the date of this prospectus, without the prior written consent of Bear,
Stearns & Co. Inc., on behalf of the underwriters. Bear, Stearns & Co. Inc.
may, in its sole discretion and at any time without notice, release all or any
portion of the securities subject to lock-up agreements.
You will experience substantial dilution in the value of your shares
immediately following this offering.
The price of the shares being offered is substantially higher than the net
tangible book value per share. If you buy any shares in the offering, you will:
. pay a price per share that substantially exceeds the value of our assets
after subtracting our liabilities; and
. contribute almost all of the total consideration paid to date for our
common stock but will own only approximately 20.0% of our outstanding
common stock.
In addition, if option holders exercise options to purchase our common stock,
you will suffer further dilution.
CAUTIONARY NOTE ON FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that address, among
other things:
. our market opportunity;
. potential market acceptance of the products we offer;
. our strategy;
. the timing of our potential funding needs;
. our anticipated use of the proceeds of this offering; and
. competition.
Other statements about our plans, objectives, expectations and intentions
contained in this prospectus may also be forward-looking statements. In some
cases you can identify forward-looking statements by terminology, including
terms such as "believes," "anticipates," "expects," "estimates," "may," "will,"
"should," "could," "plans," "predicts," "potential," "intends" or similar
terms. We cannot assure you of future results, levels of activity, performance
or achievements. The forward-looking statements involve known and unknown
risks, uncertainties and other factors that may cause actual results to be
materially different from any future results or events described or expressed
in or implied by the forward-looking statements. These factors include those
identified under "Risk Factors" and elsewhere in this prospectus. We undertake
no obligation to update any of the forward-looking statements after the date of
this prospectus, even if new information becomes available or other events
occur in the future, except as otherwise required by law. All forward-looking
statements contained in this prospectus are expressly qualified in their
entirety by this cautionary notice.
23
<PAGE>
USE OF PROCEEDS
We anticipate that our net proceeds from the sale of 5,000,000 shares of
common stock will be approximately $67.8 million, or $78.2 million if the
underwriters exercise their over-allotment option in full, based upon an
assumed initial public offering price of $15.00 per share and after deducting
underwriting discounts and commissions and estimated offering expenses.
The principal purposes of this offering are to increase our working capital,
to create a public market for our common stock, to facilitate our future access
to the public capital markets and to increase our visibility in the home and
small office networking marketplace. We currently do not have a specific plan
that allocates the net proceeds of this offering. The amounts and timing of any
expenditures will vary significantly depending upon a number of factors,
including the amount of cash generated by our operations, the progress of our
product development efforts and the market response to introduction of new
products. We may use a portion of the net proceeds to acquire complementary
products, technologies or businesses to expand internationally or to make
strategic investments. We currently have no agreements with respect to any such
acquisitions, expansion or investments. Pending any of these uses, we intend to
invest the net proceeds in short-term, investment-grade, interest-bearing
securities.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our capital stock and
we do not anticipate paying any cash dividends on our capital stock in the
future. We currently intend to retain any future earnings for use in our
business. Payments of future dividends, if any, will be at the discretion of
our board of directors and will depend on our results of operations, financial
condition, contractual and legal restrictions and other factors the board of
directors deems relevant.
24
<PAGE>
CAPITALIZATION
The following table shows as of September 30, 2000:
. our actual capitalization; and
. our pro forma capitalization, as adjusted to reflect the application of
the estimated net proceeds of $67.8 million from the sale of 5,000,000
shares of our common stock at an assumed initial public offering price
of $15.00 per share, after deducting estimated underwriting discounts
and commissions and estimated offering expenses.
<TABLE>
<CAPTION>
September 30,
2000
------------------
As
Actual Adjusted
-------- --------
(in thousands,
except share
amounts)
<S> <C> <C>
Stockholders' equity (net deficit):
Preferred stock, par value $0.001 per share; 30,000,000
shares authorized, none outstanding..................... -- --
Common stock, par value $0.001 per share; 100,000,000
shares authorized; 20,050,000 shares issued and
outstanding, actual; 25,050,000 shares issued and
outstanding, pro forma as adjusted...................... 20 25
Unearned compensation.................................... (2,653) (2,653)
Additional paid-in capital............................... 6,789 74,534
Retained earnings (deficit).............................. (12,005) (12,005)
-------- --------
Total stockholders' equity (net deficit)............... $ (7,849) $ 59,901
======== ========
</TABLE>
The number of shares issued and outstanding as of September 30, 2000,
excludes:
. 1,450,000 shares of common stock issuable upon exercise of stock options
outstanding as of September 30, 2000, at a weighted average exercise
price of $0.001 per share;
. 240,000 shares of common stock issuable upon exercise of stock options
to be granted at an exercise price equal to 70% of the initial public
offering price per share;
. 2,050,000 shares of common stock available for future grant of options
under our 1999 Stock Plan as of September 30, 2000, which plan will be
terminated effective upon completion of this offering; and
. 3,110,000 shares of common stock available for future issuance under our
2000 Equity Incentive Plan and 2000 Employee Stock Purchase Plan.
25
<PAGE>
DILUTION
If you invest in our common stock, your interest will be diluted to the
extent of the difference between the initial public offering price per share
and the net tangible book value per share after this offering. We calculate net
tangible book value or deficit per share by dividing the net tangible book
value, which is total assets less intangible assets and total liabilities, by
the number of then-outstanding shares of common stock.
Our net tangible book deficit at September 30, 2000, was $7.8 million, or
$0.39 per share of common stock. After giving effect to the sale of 5,000,000
shares of our common stock in this offering at an assumed initial public
offering price of $15.00 per share, less estimated underwriting discounts and
commissions and estimated offering expenses, our net tangible book value at
September 30, 2000, would have been $59.9 million, or $2.39 per share. This
represents an immediate increase in the net tangible book value of $2.78 per
share to existing stockholders and an immediate and substantial dilution of
$12.61 per share to new investors. The following table illustrates this per-
share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share............. $15.00
Net tangible book deficit per share as of September 30,
2000..................................................... $(0.39)
Increase per share attributable to new investors.......... 2.78
------
Pro forma net tangible book value per share after the
offering .................................................. 2.39
------
Dilution per share to new investors......................... $12.61
======
</TABLE>
The following table shows, at September 30, 2000, the number of shares of
common stock purchased from us, the total consideration paid and the average
price paid per share by existing stockholders and by new investors purchasing
common stock in this offering.
<TABLE>
<CAPTION>
Shares Purchased Total Consideration
------------------ ------------------- Average Price
Number Percent Amount Percent Per Share
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders.. 20,050,000 80.0% $ 20,050 0.0% $0.001
New investors.......... 5,000,000 20.0 75,000,000 100.0 15.00
---------- ----- ----------- -----
Total................ 25,050,000 100.0% $75,020,050 100.0%
========== ===== =========== =====
</TABLE>
The number of shares of common stock issued and outstanding as of September
30, 2000, excludes:
. 1,450,000 shares of common stock issuable upon exercise of stock options
outstanding as of September 30, 2000, at a weighted average exercise
price of $0.001 per share;
. 240,000 shares of common stock issuable upon exercise of stock options
to be granted at an exercise price equal to 70% of the initial public
offering price per share;
. 2,050,000 shares of common stock available for future grant of options
under our 1999 Stock Plan as of September 30, 2000, which plan will be
terminated effective upon completion of this offering; and
. 3,110,000 shares of common stock available for future issuance under our
2000 Equity Incentive Plan and 2000 Employee Stock Purchase Plan.
To the extent that options or stock purchase rights are exercised, new
investors will experience further dilution.
26
<PAGE>
SELECTED FINANCIAL DATA
(in thousands, except per share data)
The following selected financial data should be read in conjunction with our
financial statements and related notes, "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and other financial
information included elsewhere in this prospectus. The statement of operations
data presented below for the period July 1, 1997 (inception), to December 31,
1997, and for the years ended December 31, 1998 and 1999, and the balance sheet
information at December 31, 1998 and 1999 (as restated), presented below are
derived from our audited financial statements, which have been audited by
Deloitte & Touche llp, independent public accountants, and together with their
related report, are included elsewhere in this prospectus. The information as
of and for the year ended December 31, 1999, is presented as restated. See
note 8 of notes to the financial statements.
The balance sheet data as of December 31, 1997, are derived from unaudited
financial statements not included in this prospectus. The statement of
operations data for the nine months ended September 30, 1999 and 2000, and the
balance sheet data at September 30, 2000, are derived from unaudited financial
statements included elsewhere in this prospectus. In the opinion of management,
these statements have been prepared on the same basis as the audited financial
statements and include all adjustments, which include only normal recurring
adjustments, necessary for a fair presentation of the information for these
periods.
<TABLE>
<CAPTION>
Nine Months
July 1, 1997 Year Ended Ended
(inception) to December 31, September 30,
December 31, ---------------------- ----------------
1997 1998 1999 1999 2000
-------------- ------- ------------- ------- -------
(As restated,
see note 8)
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data(1):
Net revenues............ $ 134 $ 2,997 $15,893 $ 9,941 $21,322
Cost of revenues........ 56 1,143 8,980 5,187 12,907
----- ------- ------- ------- -------
Gross profit............ 78 1,854 6,913 4,754 8,415
----- ------- ------- ------- -------
Operating expenses:
Research and
development.......... 1 71 712 571 1,110
Sales and marketing... 43 2,583 8,844 5,684 10,769
General and
administrative....... 305 1,031 2,879 1,955 3,202
Non-cash stock-based
compensation......... -- -- 1,829 -- 1,494
----- ------- ------- ------- -------
Total operating
expenses........... 349 3,685 14,264 8,210 16,575
----- ------- ------- ------- -------
Interest income......... -- -- 2 -- 48
----- ------- ------- ------- -------
Net loss................ $(271) $(1,831) $(7,349) $(3,456) $(8,112)
===== ======= ======= ======= =======
Basic and diluted net
loss per common share.. $ (0.40)
=======
Weighted average shares
used to compute basic
and diluted net loss
per common share....... 20,050
=======
Pro forma basic and
diluted net loss per
common share........... $ (0.37)
=======
Weighted average shares
used to compute pro
forma basic and diluted
net loss per common
share.................. 20,050
=======
</TABLE>
<TABLE>
<CAPTION>
December 31,
------------------------- September 30,
1997 1998 1999 2000
---- ----- ------------- -------------
(As restated,
see note 8)
<S> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents............. $ -- $ -- $ 1,878 $ 2,323
Working capital (deficit)............. 74 (759) (2,012) (9,496)
Total assets.......................... 101 827 2,070 5,226
Total stockholders' equity (owner's
net deficit)......................... 74 (759) (1,953) (7,849)
</TABLE>
----------
(1) We were operated and financed for approximately two years as a division of
X-10 (USA). On October 1, 1999, X10 Ltd. and X-10 (USA) contributed
technology and other intellectual property and net assets to us. Through
September 30, 1999, our selected statement of operations and balance sheet
data above are derived from the historic books and records of X10 Ltd. and
include cost allocations from X10 Ltd. and X-10 (USA).
27
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the financial
statements and the related notes contained elsewhere in this prospectus.
Overview
We offer an integrated suite of affordable products that allow consumers to
network devices, systems and appliances within homes and small offices using
broadband wireless, electrical, phoneline and infrared technologies. These
products allow users to access and control home and small office networks
directly from a personal computer or through the use of remote controls, wall-
mounted panels, telephones or the Internet.
We were operated and financed for approximately two years as a division of
X-10 (USA). We were incorporated as a separate company in July 1999. On October
1, 1999, X10 Ltd. and X-10 (USA) contributed and licensed technology and other
intellectual property and net assets to us. Through September 30, 1999, our
statements of operations and balance sheets are derived from the historic books
and records of X10 Ltd. and include cost allocations from X10 Ltd. and X-10
(USA). These costs are not necessarily indicative of the costs that would have
been incurred on a stand-alone basis. Since the commercial launch of our
website in July 1997, we have continued our operating activities with a focus
on designing and developing broadband wireless products, building sales
momentum, expanding the line of products we offer, building business
relationships and promoting the X10 brand name.
We have worldwide rights to the X10 brand, and we sell X10 products over the
Internet. Under our agreements with X10 Ltd., we receive fees on all wireless
products sold by X10 Ltd. and, where we have provided the introduction, on
electrical products sold by X10 Ltd. to original equipment manufacturers and
other resellers that sell customized, bundled or private-label versions of the
products we offer. We also receive fees on all X10-branded products sold by X-
10 (USA). Under the terms of our amended and restated sublicense agreement with
X-10 (USA), X-10 (USA) currently may sell only X10-branded electrical products
to resellers in the western hemisphere. We have a contract with X10 Ltd. to
supply us with products, and we have access to the development engineers and
manufacturing facilities of X10 Ltd. and its affiliates in Hong Kong and China.
X10 Ltd., together with its affiliates, manufactures the products we sell and
ships the products on a consignment basis to a warehouse designated by us
pursuant to a product supply agreement. We are obligated to purchase the
products on the earlier of receipt of a purchase order from a customer or 120
days from delivery of the products by X10 Ltd. to the shipper. We have also
outsourced to X-10 (USA) the warehousing, packaging and shipping of products to
customers. This structure is intended to allow us to focus on designing and
selling our products while maintaining an efficient fulfillment process.
All Internet customer orders are processed online and billed to the
customers' credit cards. Generally, we collect cash from credit card sales, net
of a fee charged by the credit card company, in most cases within two days from
the order date. We routinely offer promotional discounts and coupons to
customers. In addition, if a customer is not satisfied with a particular
product we provide, we generally refund all or a portion of the sales price.
During the quarter ended June 30, 2000, we began direct sales to retailers and
other resellers. We do not require collateral or other security to support
credit sales, but we intend to establish an allowance for uncollectible
accounts as appropriate.
We have incurred net losses of approximately $17.6 million from July 1,
1997, our inception date, to September 30, 2000. We believe that we will
continue to incur net losses for the foreseeable future. We have a limited
operating history on which to base an evaluation of our business and prospects.
Our prospects must be considered in light of the risks, expenses and
difficulties typically encountered by companies in their early stages of
development, particularly companies in new and rapidly evolving markets such as
ours. See "Risk Factors" for a more complete description of the risks we face.
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<PAGE>
In view of our limited operating history and the rapidly evolving nature of
our business, we believe that period-to-period comparisons of our operating
results may not be indicative of future performance. It is possible that in
some future period our operating results may fall below the expectations of
securities analysts and investors. In that event, the trading price of our
common stock may fall significantly.
Net Revenues. Net revenues consist of product sales, net of allowances for
returns and discounts, and license fees. We recognize revenues on product sales
when the product is shipped to the customer. We receive fees from X-10 (USA)
equal to 15% of X-10 (USA)'s sales of X10-branded products, net of trade
discounts, allowances, sales tax, freight charges and returns to resellers.
Under our sublicense agreement with X-10 (USA), we received a fee of at least
$250,000 per quarter during the 12-month period ended September 30, 2000. We
will receive a fee of at least $500,000 per quarter during the 12-month period
ending September 30, 2001, $750,000 per quarter during the 12-month period
ending September 30, 2002 and no minimum fee thereafter. During the nine-month
period ended September 30, 2000, fees from X-10 (USA) totaled $776,000.
We also receive a variable fee on X10 Ltd.'s sales of wireless products to
sellers of customized, bundled or private-label products and on X10 Ltd.'s
sales of electrical products to these resellers that we introduce to X10 Ltd.
pursuant to a contract manufacturing agreement. Our fee is equal to the sales
price of the products sold by X10 Ltd., which we negotiate with these
resellers, less costs including materials, labor, overhead and consumables, and
less a manufacturing fee retained by X10 Ltd. This manufacturing fee is equal
to 15% of the net sales price of each product sold until aggregate sales of
that product reach $2.0 million, and 10% of the net sales price of that product
thereafter. We establish the terms of sales by X10 Ltd. of wireless products on
a case-by-case basis. During the nine-month period ended September 30, 2000,
fees from X10 Ltd. for sales to customized, bundled or private-label product
resellers totaled $1.2 million. We also have the right to sell wireless
products directly to these resellers.
Cost of Revenues. Cost of revenues consists primarily of the cost of
products sold to customers. The cost of promotional items provided in
connection with product sales is included in cost of revenues. X10 Ltd. and its
affiliates manufacture the products we sell under our product supply agreement.
We pay X10 Ltd. a fee equal to the costs incurred by X10 Ltd. to produce the
products as well as the cost of shipment to the warehouse.
Research and Development Expenses. Research and development expenses consist
primarily of salaries and related benefits for our technology and product
development personnel and an allocation of related overhead costs. In addition,
we entered into a research and development agreement with X10 Ltd. that
provides for us to obtain product research and development services from X10
Ltd. and its affiliates upon our request and pursuant to our specifications in
exchange for a service fee established by X10 Ltd. on a project-by-project
basis. During the nine months ended September 30, 2000, we incurred $450,000 in
fees to X10 Ltd. for research and development.
Sales and Marketing Expenses. Sales and marketing expenses consist primarily
of Internet access and hosting charges, fulfillment costs, including shipping
and handling, advertising and promotional expenditures, the cost of promotional
products provided to attract customers, and payroll and related expenses for
personnel engaged in marketing, public relations and customer service
activities. We currently use X-10 (USA) to warehouse, process and ship the
products we sell to our Internet customers pursuant to a fulfillment services
agreement. We pay X-10 (USA) a service fee to ship the products equal to 10% of
our gross receipts for the products we sell, excluding sales and other taxes.
General and Administrative Expenses. General and administrative expenses
consist of payroll and related expenses for executive and administrative
personnel, customer service costs, corporate facility expenses, professional
services, travel and other general corporate expenses.
Income Taxes. We were operated as a division of X-10 (USA) until October 1,
1999. Prior to that date, the results of our operations were included in the
consolidated returns filed by X-10 (USA). There was no
29
<PAGE>
provision or benefit for income taxes allocated to us for any period from
inception through October 1, 1999 as the tax allocation process utilized by X10
Ltd. did not allocate tax benefits to the division.
Since October 1, 1999, we have generated operating loss carryforwards for
federal income tax purposes and will commence filing separate tax returns with
respect to periods subsequent to our incorporation. To the extent that single-
year losses are not utilized to the full amount of the limitation, unused
losses are carried over to subsequent years until the earlier of their
utilization or the expiration of the relevant carryforward period. We have
provided a full valuation allowance on the deferred tax asset, consisting
primarily of these net operating loss carryforwards, because of uncertainty
regarding its realizability. See note 6 of notes to financial statements.
Restatement
Subsequent to the issuance of our financial statements as of and for the
year ended December 31, 1999, management determined that the deemed fair value
of our common stock, as used for accounting purposes to measure compensation
expense related to stock options granted to employees and directors, should be
$2.49 per share, rather than $0.40 per share. In addition, we have recognized
compensation expense relating to the shares of our common stock sold by George
Stevenson, our chief executive officer and chairman of our board, to three of
our employees on October 1, 1999, for less than the deemed fair value per share
on that date.
Our financial statements as of and for the year ended December 31, 1999,
have been restated from the amounts previously reported to recognize additional
non-cash stock-based compensation expense of $1.8 million and unearned
compensation of $2.6 million based upon the deemed fair value of our common
stock and options. Additional paid-in capital has also been increased by $4.4
million. A summary of the significant effects of the restatement is as follows:
<TABLE>
<CAPTION>
As previously As
reported restated
------------- --------
(in thousands, except
per share amounts)
<S> <C> <C>
For the year ended December 31, 1999:
Non-cash stock-based compensation...................... 76 1,829
Net loss............................................... (5,596) (7,349)
Pro forma basic and diluted net loss per common share.. $ (.28) $ (.37)
At December 31, 1999:
Unearned compensation.................................. $ (504) $(3,139)
Additional paid-in capital............................. 671 5,059
Retained earnings (deficit)............................ (2,140) (3,893)
</TABLE>
30
<PAGE>
Results of Operations
The following table sets forth the results of our operations, expressed as
percentages of net revenues:
<TABLE>
<CAPTION>
July 1, 1997 Year Ended Nine Months
(inception) December Ended
to 31, September 30,
December 31, ------------- ---------------
1997 1998 1999 1999 2000
------------ ----- ----- ------ ------
<S> <C> <C> <C> <C> <C>
Net revenues.................... 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
Cost of revenues................ 41.8 38.1 56.5 52.2 60.5
------ ----- ----- ------ ------
Gross profit.................... 58.2 61.9 43.5 47.8 39.5
------ ----- ----- ------ ------
Operating expenses:
Research and development....... 0.7 2.4 4.5 5.7 5.2
Sales and marketing............ 32.1 86.2 55.6 57.2 50.5
General and administrative..... 227.6 34.4 18.1 19.7 15.0
Non-cash stock-based
compensation.................. -- -- 11.5 -- 7.0
------ ----- ----- ------ ------
Total operating expenses...... 260.4 123.0 89.7 82.6 77.7
Interest income................. -- -- -- -- 0.2
------ ----- ----- ------ ------
Net loss........................ (202.2)% (61.1)% (46.2)% (34.8)% (38.0)%
====== ===== ===== ====== ======
</TABLE>
Fiscal 1997, 1998 and 1999
Net Revenues. Our website was commercially launched on July 1, 1997. Our net
revenues, including license fees, increased by $2.9 million, from $134,000 in
1997 to $3.0 million in 1998, and by $12.9 million to $15.9 million in 1999.
Substantially all of the increases in net revenues from 1997 to 1998 and from
1998 to 1999 were due to increases in the volume of product sales, including
sales of new products. License fees derived from our sublicense agreement with
X-10 (USA) were $261,000 for 1999 compared with none in 1998 and 1997.
Cost of Revenues. Our cost of revenues increased by $1.1 million, from
$56,000 in 1997 to $1.1 million in 1998, and by $7.9 million to $9.0 million in
1999. As a percentage of net revenues, our cost of revenues decreased from
41.8% in 1997 to 38.1% in 1998 and increased to 56.5% in 1999. The increase in
cost of revenues as a percentage of net revenues in 1999 compared with 1998 was
primarily due to a higher level of promotional items sent to customers free of
charge. The increase was partially offset by efficiencies associated with
increased transaction volume, the allocation of fixed costs, such as the
operation of our data center, and license fees beginning in the fourth quarter
of 1999.
We intend to continue offering purchase incentives to our customers,
including promotional items free of charge and vouchers entitling the customer
to a reduction of sales price on future purchases. We cannot predict the extent
or mix of sales promotions to be offered in the future. However, to the extent
these sales promotions are increased, they may decrease our gross margin.
Research and Development Expenses. Research and development expenses
increased by $70,000, from $1,000 in 1997 to $71,000 in 1998, and by $641,000
to $712,000 in 1999. Research and development expenses as a percentage of net
revenues increased from 0.7% in 1997 to 2.4% in 1998 and to 4.5% in 1999. The
increase in research and development expenses in 1999 was due to expanded
development efforts, including increased personnel and consulting costs.
Sales and Marketing Expenses. Sales and marketing expenses increased by $2.6
million, from $43,000 in 1997 to $2.6 million in 1998, and by $6.2 million to
$8.8 million in 1999. These increases in sales and marketing expenses resulted
primarily from increases in Internet-based advertising expenditures. The
increase in sales and marketing expenses during 1999 also reflected the cost of
a promotional product, which we began providing at no charge and with no
purchase requirement in 1999 in order to attract potential customers. The
31
<PAGE>
net expense for this promotional product was $843,000 in 1999 compared with
none in 1998. Sales and marketing expenses as a percentage of net revenues
increased from 32.1% in 1997 to 86.2% in 1998 and then decreased to 55.6% in
1999. The increase in 1998 was primarily due to higher start-up sales and
marketing expenses in 1998 relative to revenues as we accelerated our marketing
efforts.
Fulfillment and order processing expenses include fulfillment fees charged
by X-10 (USA), and payroll and related expenses for personnel engaged in
customer service, distribution and fulfillment activities. Fulfillment costs
were $380,000 in 1998 compared with $1,508,785 in 1999. The growth in
fulfillment costs was directly related to the increase in order volume.
General and Administrative Expenses. General and administrative expenses
increased by $695,000, from $305,000 in 1997 to $1.0 million in 1998, and by
$1.9 million to $2.9 million in 1999. The increase in 1998 compared with 1997
primarily reflected the full year of operations in 1998 compared with six
months of operations in 1997 and the growth in our operations from 1997 to
1998. The increase in expenses in 1999 compared with 1998 was primarily due to
increases in headcount and occupancy costs, credit card merchant fees and
allocated costs from X-10 (USA). As a percentage of net revenues, general and
administrative costs decreased from 227.6% in 1997 to 34.4% in 1998 and 18.1%
in 1999, primarily as a result of increases in our revenue base.
Non-Cash Stock-Based Compensation. In connection with the issuance of stock
options in October 1999, we recorded unearned compensation in the aggregate
amount of $3.6 million. This amount represented the difference between the
deemed fair value of our common stock and the exercise price of the stock
options at the date of grant. We are amortizing the unearned compensation
relating to stock options using the accelerated method over the applicable
vesting period, which is 48 months. Amortization expense was $470,000 for the
year ended December 31, 1999.
On October 1, 1999, George Stevenson, our chief executive officer and
chairman of our board, sold 650,000 shares of common stock to three of our
employees at less than the deemed fair value per share on that date, which
resulted in a charge to non-cash stock-based compensation of $1.4 million. We
recognized this amount entirely during the year ended December 31, 1999.
Income Taxes. As of December 31, 1999, we had net operating loss
carryforwards of approximately $1.9 million for federal purposes, which will
expire beginning in 2019.
Nine Months Ended September 30, 1999 and 2000
Net Revenues. Net revenues, including fees, increased by $11.4 million, from
$9.9 million in the nine months ended September 30, 1999 to $21.3 million in
the nine months ended September 30, 2000. This increase was primarily due to
increases in the volume of product sales, particularly sales of our new
wireless products. License fees, which were derived from our sublicensing
agreement with X-10 (USA), were $776,000 for the first nine months ended
September 30, 2000 compared with none in the nine months ended September 30,
1999.
Cost of Revenues. Our cost of revenues increased by $7.7 million, from $5.2
million in the nine months ended September 30, 1999 to $12.9 million in the
nine months ended September 30, 2000. As a percentage of net revenues, our cost
of revenues increased from 52.2% in the nine months ended September 30, 1999 to
60.5% in the nine months ended September 30, 2000. The increase in cost of
revenues in actual dollars and as a percentage of net revenues was primarily
due to a higher level of promotional items sent to customers free of charge, as
well as pricing discounts beginning in the third quarter of 1999, and was
partially offset by fees from X-10 (USA) under a sublicense agreement beginning
in the fourth quarter of 1999.
Research and Development Expenses. Research and development expenses
increased by $529,000, from $571,000 in the nine months ended September 30,
1999 to $1.1 million in the nine months ended
32
<PAGE>
September 30, 2000. The increase in research and development expenses was due
to increased personnel, recruitment and related overhead costs. We believe our
product and technology development efforts are critical to the success of our
strategic objectives and, accordingly, we expect the level of research and
development expenditures to increase in future periods.
Sales and Marketing Expenses. Sales and marketing expenses increased by $5.1
million, from $5.7 million in the nine months ended September 30, 1999 to $10.8
million in the nine months ended September 30, 2000, primarily as a result of
increases in advertising expenditures. As a percentage of net revenues, sales
and marketing expenses decreased from 57.2% in the nine months ended September
30, 1999, to 50.5% in the nine months ended September 30, 2000, primarily
reflecting an increase in our revenue base. We anticipate that, in future
periods, sales and marketing expenses will increase in absolute dollars as we
expand our sales force.
General and Administrative Expenses. General and administrative expenses
increased by $1.2 million, from $2.0 million in the nine months ended September
30, 1999 to $3.2 million in the nine months ended September 30, 2000. This
increase resulted primarily from increases in headcount and credit card
merchant fees. As a percentage of net revenues general and administrative
expenses decreased from 19.7% in the nine month period ended September 30, 1999
to 15.0% in the nine month period ended September 30, 2000, primarily due to
the impact of fixed costs and an increase in our revenue base. We expect that
general and administrative expenses will increase as we expand our staff and
incur additional costs in anticipation of growth as well as costs associated
with operating as a public company.
Non-Cash Stock-Based Compensation. Amortization expense was $1.5 million in
the nine months ended September 30, 2000. There was no amortization expense in
the nine months ended September 30, 1999. We expect to continue to recognize
amortization expense related to non-cash stock-based compensation in the future
in connection with stock option grants to our non-employee directors and
employees.
Quarterly Results of Operations
Because we have a limited operating history, we believe that period-to-
period comparisons may not be meaningful. Our quarterly results of operations
have varied significantly and may continue to vary significantly in the future
as a result of a number of factors, many of which are outside of our control.
For a discussion of risks relating to our quarterly results of operations, see
"Risk Factors--Our quarterly results of operations may vary significantly and
may fail to meet the expectations of securities analysts or investors, which
may cause our stock price to fluctuate."
The following table sets forth our unaudited quarterly statement of
operations data for the eight quarterly periods in 1998 and 1999 and for the
three quarters in the nine-month period ended September 30, 2000. This
quarterly information has been derived from our unaudited financial statements
and, in the opinion of management, includes all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation of this
information in accordance with generally accepted accounting principles. The
operating results for any quarter are not necessarily indicative of the
operating results for a full year or for any future period.
33
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended
-------------------------------------------------------
March 31, June 30, September 30, December 31, March 31,
1998 1998 1998 1998 1999
--------- -------- ------------- ------------ ---------
(in thousands)
<S> <C> <C> <C> <C> <C>
Net revenues............ $ 190 $ 405 $ 706 $1,696 $ 2,745
Cost of revenues........ 92 262 157 632 1,244
----- ----- ----- ------ -------
Gross profit............ 98 143 549 1,064 1,501
----- ----- ----- ------ -------
Operating expenses:
Research and
development.......... 1 1 29 40 87
Sales and marketing... 90 412 757 1,324 1,903
General and
administrative....... 222 216 246 347 536
----- ----- ----- ------ -------
Total operating
expenses........... 313 629 1,032 1,711 2,526
----- ----- ----- ------ -------
Net loss................ $(215) $(486) $(483) $ (647) $(1,025)
===== ===== ===== ====== =======
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------------------------------------------
June 30, September 30, December 31, March 31, September 30,
1999 1999 1999 2000 June 30, 2000 2000
-------- ------------- ------------ ------------- ------------- -------------
(As
restated, (As restated, (As restated,
see note 8) see note 8) see note 8)
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Net revenues............ $ 2,678 $ 4,518 $ 5,952 $ 6,207 $ 6,230 $ 8,885
Cost of revenues........ 1,309 2,634 3,793 3,926 4,025 4,956
------- ------- ------- ------- ------- -------
Gross profit............ 1,369 1,884 2,159 2,281 2,205 3,929
------- ------- ------- ------- ------- -------
Operating expenses:
Research and
development.......... 153 331 141 208 379 523
Sales and marketing... 2,068 1,713 3,160 4,107 3,269 3,393
General and
administrative....... 553 866 924 1,073 1,004 1,125
Non-cash stock-based
compensation......... -- -- 1,829 470 470 554
------- ------- ------- ------- ------- -------
Total operating
expenses........... 2,774 2,910 6,054 5,858 5,122 5,595
------- ------- ------- ------- ------- -------
Loss from operations.... (1,405) (1,026) (3,895) (3,577) (2,917) (1,666)
Interest income......... -- -- 2 13 8 27
------- ------- ------- ------- ------- -------
Net loss................ $(1,405) $(1,026) $(3,893) $(3,564) $(2,909) $(1,639)
======= ======= ======= ======= ======= =======
</TABLE>
Net Revenues. Our net revenues increased sequentially from $190,000 in the
first quarter of 1998 to $8.9 million in the third quarter of 2000, except for
the second quarter of 1999 in which our net revenues decreased by $67,000 to
$2.7 million. Growth in revenues was generally attributable to increased sales
of products to new and existing customers. The increase in net revenues of $1.8
million for the third quarter of 1999 to $4.5 million in the subsequent quarter
was primarily due to developments made to our website as well as seasonal
factors. Net revenues increased by $2.7 million for the third quarter of 2000
as a result of the commencement of sales, indirectly through our affiliates, to
sellers of customized, bundled or private-label versions of the products we
offer to retailers, independent contractors and value-added resellers. The
allowance for sales returns decreased as a percentage of net sales from 5.0%
for the quarter ended December 31, 1999, to 2.0% for the quarter ended
September 30, 2000. The allowance for returns provision charged to the
statement of operations also decreased from 8.4% in the quarter ended December
31, 1999, to 2.6% in the quarter ended September 30, 2000, respectively. This
decrease was made primarily to reflect the reduction in product returns due to
improved telephone customer service support.
34
<PAGE>
Cost of Revenues. Our cost of revenues increased from $92,000 in the first
quarter of 1998 to $262,000 in the second quarter of 1998, and increased from
$157,000 in the third quarter of 1998 to $5.0 million for the
third quarter of 2000. Cost of revenues decreased in the third quarter of 1998
primarily as a result of changes in product mix. Gross profit fluctuated widely
during 1998 primarily due to variations in product sales mix and promotional
activities. Fluctuations in gross margin during 1998, 1999 and 2000 were
principally due to timing of promotional programs. The increase in gross margin
in the third quarter of 2000 reflects the commencement of sales to customized,
bundled or private-label product resellers, which sales have higher gross
margins than direct product sales and increased gross margins on sales over the
Internet. We expect to continue to offer promotional items in the future to
attract customers and promote sales.
Operating Expenses. Operating expenses increased sequentially from $313,000
in the first quarter of 1998 to $6.1 million in the last quarter of 1999.
Operating expenses declined by $1.0 million from $6.1 million in the last
quarter of 1999 to $5.1 million in the second quarter of 2000. Generally,
operating expenses as a percentage of net revenues fluctuated throughout the
period due to changes in the level of advertising and promotional items.
Operating expenses increased by $3.1 million to $6.1 million in the last
quarter of 1999 from the immediately preceding quarter due to increased
advertising activities and the recognition of $1.8 million of non-cash stock-
based compensation. Operating expenses decreased by $200,000 in the first
quarter of 2000 due to lower non-cash stock-based compensation that was
partially offset by increased advertising expenses. During the second quarter
of 2000, operating expenses decreased by $800,000 due to improved efficiencies
in our sales and marketing activities, including improvements to our Internet
banner advertisements and our web pages.
Liquidity and Capital Resources
Historically, we have financed our activities with $5.1 million in capital
contributions from X10 Ltd. However, X10 Ltd. will not continue to be a source
of liquidity for us following this offering. We had an accumulated deficit of
$12.0 million at September 30, 2000. We do not have a credit facility and are
not currently negotiating with any party to obtain a credit facility. As of
September 30, 2000, we had $2.3 million in cash and cash equivalents. Under the
terms of our product supply agreement with X10 Ltd., we are obligated to
purchase product 120 days after delivery to X-10 (USA) by X10 Ltd. As of
September 30, 2000, our purchase obligation for X10 Ltd. product held at
X-10 (USA) warehouses was approximately $5.7 million.
We expect to experience significant growth in our operating expenses for the
foreseeable future in order to execute our business plan. We may use cash for
general working capital and to fund capital expenditures, acquisitions or
invest in complementary products, technologies or businesses. However, we
currently do not have a specific plan that allocates cash to any of these
categories. We currently anticipate that the net proceeds of this offering,
together with our available funds, will be sufficient to meet our anticipated
needs for working capital and capital expenditures through at least the next
12 months. We may need to raise additional funds prior to the expiration of
this period or thereafter. If we raise additional funds through the issuance of
equity, equity-related or debt securities, these securities may have rights,
preferences or privileges senior to those of the rights of our common stock,
and our stockholders may experience additional dilution. We cannot be certain
that additional financing will be available to us on acceptable terms when
required, if at all.
Quantitative and Qualitative Disclosures About Market Risk
We have assessed our exposure to certain market risks, including interest
rate risk associated with financial instruments included in cash and cash
equivalents. Due to the short-term nature of these investments and our
investment policies and procedures, we have determined that the risk associated
with interest rate fluctuations related to these financial instruments does not
pose a material risk to us. Currently, all payments we make under our
agreements with X10 Ltd. are in U.S. dollars and, as a result, we do not
anticipate that foreign exchange gains or losses will pose a significant market
risk. We may, however, experience adverse market risks if we incur debt, hold
derivative financial instruments or engage in foreign currency transactions in
the future.
35
<PAGE>
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards, or SFAS, No. 133, Accounting for
Derivative Instruments and Hedging Activities. SFAS No. 133, as amended, is
effective for fiscal years beginning after June 15, 2000. SFAS No. 133 requires
that all derivative instruments be recorded on the balance sheet at their fair
value. Changes in the fair value of derivatives are recorded each period in
current earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction and, if it is, the type
of hedge transaction. We do not expect that the adoption of SFAS No. 133 will
have a material impact on our financial statements because we do not currently
hold any derivative instruments.
In December 1999, the SEC staff released Staff Accounting Bulletin No. 101,
Revenue Recognition in Financial Statements, or SAB No. 101, which provides
guidance on the recognition, presentation and disclosure of revenue in
financial statements. SAB No. 101 is applicable in the quarter ending December
31, 2000, and is not expected to have a significant impact on us.
In October 1999, the SEC identified a list of issues that have arisen in
Internet businesses that the SEC believes should be addressed by the Emerging
Issues Task Force, or EITF, of the FASB or other standard-setting bodies. One
such issue is EITF Issue No. 99-19, Reporting Revenue Gross as a Principal
Versus Net as an Agent. EITF Issue No. 99-19 impacts whether revenues are
presented on a gross or net basis in a company's statement of operations. Based
on our understanding of the consensus reached at the July EITF meeting, we do
not believe that EITF Issue No. 99-19 will impact our presentation of revenues.
While the EITF is in the process of addressing additional issues raised by the
SEC, many of the identified issues have not yet been resolved. Future
resolution of the issues identified by the SEC may affect our financial
statements. We are not able to determine the impact on our financial
statements, if any, of such future rule-making.
36
<PAGE>
BUSINESS
Overview
We offer affordable products that allow consumers to network devices,
systems and appliances within homes and small offices as well as remotely via
the Internet. These products are based on broadband technologies as well as
other wireless, phoneline, electrical and infrared technologies. Our products
allow users to access and control home networks directly from a PC or through
remote controls, wall-mounted panels, telephones or the Internet. We design,
develop and market broadband wireless products that enable users to receive and
deliver video and audio content throughout the home or small business and to
distribute broadband Internet content from a PC to televisions, stereos and
other electronic entertainment devices within a home or small office network.
In addition, we offer networking solutions based on other technologies that
enable consumers to control security, lighting, heating and air conditioning
systems. All of these products are compatible with each other and can operate
together to create a home or small office network. We sell these broadband
wireless and control products primarily over the Internet. In addition, we have
recently started selling these products, indirectly through our affiliates, to
sellers of customized, bundled or private label versions of these products, to
retailers, independent contractors and value-added resellers.
In July 1997, we began operations as a division of X-10 (USA), a wholly
owned subsidiary of X10 Ltd., a Hong Kong-based company that, together with its
affiliates, designs and manufactures home control, entertainment and security
technology products. On October 1, 1999, we began operating as a separate
entity selling primarily home automation and security products and a limited
selection of wireless products. We have changed our focus to the design,
development and sale of broadband wireless products. We have entered into
several agreements with X10 Ltd. and X-10 (USA) relating to the transfer of
technology and other intellectual property rights and net assets, the
manufacture and distribution by them and their affiliates of products
incorporating the technology and intellectual property rights, and the
provision of research and development services to us.
Industry Background
In recent years, there has been a dramatic increase in the availability of
complex multimedia content. The increased availability of this type of content,
together with the growth in Internet use in the workplace to access data,
streamline communications, conduct meetings and execute transactions, has
driven demand for high-capacity applications, such as e-commerce, streaming
audio and video and e-mail, as well as other multimedia and productivity-
enhancing services. Traditionally, high-speed data connections have been
achieved using T-1 and fiber optic lines, both of which can deliver significant
amounts of data rapidly. However, both of these alternatives are costly and, as
a result, have been used primarily by larger businesses and enterprises.
Many consumers accustomed to broadband access at work have come to expect
similar capabilities in their homes. In addition, the proliferation of the
small office environment, coupled with the increasing trend toward
telecommuting, has led to greater demand for broadband access in the home and
small office networking markets. Significant financial, technical and other
resources have been dedicated to providing this broadband service to homes and
small offices through a variety of competing broadband technologies, including
satellite transmission, high-speed digital cable and digital subscriber lines,
often referred to as DSL. According to International Data Corporation, or IDC,
an independent research firm, installation of broadband access is expected to
increase from 2.1 million U.S. households in 1999 to 21.2 million U.S.
households in 2003.
The expansion of home and small office broadband access has provided
consumers with the ability to enjoy a greater range of information and
entertainment to augment their home entertainment experiences. Consumers are
continuing to acquire multiple PCs and entertainment devices enabled for
broadband access. According to IDC, the percentage of U.S. households with two
or more PCs is expected to increase from 14.2% in 1999 to 28.5% in 2004.
Although consumers are continuing to add to the number of PCs and
entertainment devices in their homes and small offices, access to broadband
connections for those PCs and devices has typically been limited.
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Generally, broadband services, in contrast to traditional analog cable
services, are delivered to the home and small office through only one
connection, or node; most homes and small offices are not configured to
distribute broadband services internally, and the relatively high cost of these
services has made the acquisition of multiple broadband access points
prohibitive for many consumers. Similarly, many households have only one
satellite or cable set-top box or one CD or DVD player that is linked to one
audio/video output device, thus limiting the ability to deliver content to
multiple devices in different locations. As a result, consumers are often
frustrated in their desires to enjoy broadband content throughout the home or
small office. Moreover, the functions of PCs and entertainment devices are
converging, enabling these devices to be used for a variety of different
purposes. For example, PCs can be used to download and display film content
from the Internet through "video on demand" or to store and retrieve digital
audio files much like a jukebox, and set-top boxes can enable televisions to
access content through the Internet. To enhance these functions, consumers are
seeking ways to link their PCs with entertainment devices.
The rising demand for broadband access, together with the rapid growth of
multiple PCs and entertainment devices in the home and small office and the
convergence of function of many of these devices, has fueled the need for home
and small office networks that enable communications among electronic and
electrical systems that are often centered around a PC. As consumers recognize
the benefits of home and small office networks that can distribute broadband
applications, many are motivated to incorporate into their broadband networks
applications to control their environmental and security systems, electronic
devices and traditional home appliances. IDC projects that the number of U.S.
households with active home networks, which enable communications and mutual
transfers of data between two or more devices, will grow from 2.1 million
households in 1999 to 17.6 million households by 2004. For households with
multiple PCs, the need for shared broadband access to the Internet and other
resources can be even more acute, and IDC projects that 58% of multiple-PC U.S.
households will have installed active home networks by 2004.
This increasing demand for home and small office networking has led a number
of companies to develop different networking technologies designed to address
this need. These technologies rely on wireless, phoneline, electrical and
custom-installed infrastructures to provide interconnectivity. Current
development efforts are focused on wireless technology standards and protocols,
such as 802.11, 802.11a, 802.11b, HomeRF and Bluetooth, that operate in the 2.4
GHz and 5 GHz radio frequency bands. Despite the increasing number of
technologies and products targeted at creating effective home and small office
networks, currently available networking products and systems suffer from a
variety of constraints, including:
. High Cost. Incorporating currently available networking technologies
into personal computers and home entertainment devices is often costly.
The complexity of many current home and small office networking
solutions and their associated remodeling and installation expenses can
be prohibitive for many consumers.
. Difficult Installation and Use. Many networks are complex and difficult
to implement, frequently involving the addition of new wiring or
telephone jacks and often requiring installation by professional
contractors. Use and maintenance of a complex system can also be
daunting to many consumers.
. Limited Compatibility with Legacy Equipment. Many new networking
technologies may not be compatible with consumers' existing
entertainment devices and other electronic equipment. As a result, these
legacy products cannot be incorporated into the network and, in some
cases, must be replaced with network-enabled devices.
. Inability to Deliver Broadband Content. Some networking solutions lack
the speed and capacity required to distribute broadband content and,
therefore, have limited functionality.
We believe that the limitations of many currently available systems have
created a significant market opportunity for effective home and small office
networking products and systems. To address this opportunity,
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we believe that home and small office networking products and systems should be
cost-effective and easy to install and use, with sufficient capacity to enable
broadband delivery. They should also be compatible with existing electronic
devices and be easily expandable, often referred to as scalable, enabling
consumers to incorporate new components and new technologies while preserving
consumers' valuable investments in existing electronic devices.
The X10 Solution
Our products provide affordable and easy-to-install solutions for networking
devices, systems and appliances within homes and small offices. Because our
products operate with a wide variety of devices and technologies, consumers can
use them to network their existing entertainment devices and electronic and
electrical systems and appliances. The products we offer enable consumers to
deliver broadband media content received from a single connection to other
devices located throughout the home or small office and to control the physical
environment of a home or small office with a single universal remote control.
We believe that our solution offers the following advantages:
Broad Array of Compatible Products and Applications. We offer a variety of
applications that enable consumers to network devices, systems and appliances
within a home or small office. These products include wireless broadband
products that we design and develop and X10-branded automation and security
products that we have licensed from X10 Ltd. Our networking products and
systems allow consumers to deliver signals to control networked devices through
a PC, universal hand-held remote control, wall-mounted panels, telephones or
the Internet and to distribute content to multiple audio/video output devices.
Because the products we offer are compatible with most existing, widely used
home and small office electronic and electrical systems and appliances, they
can be readily implemented in almost all homes and small offices, allowing
consumers to capitalize on their prior investments in technology and electronic
and electrical systems.
Use of Multiple Networking Technologies. The products we offer employ a
variety of networking technologies, including broadband wireless, electrical,
phoneline and infrared. We design and update the products we offer to be
compatible among these multiple technologies and believe that many applications
are best implemented through a combination of technologies. For example, using
X10-branded products, a consumer could configure a security system that detects
intruders with a motion sensor, turns on a video camera, delivers the broadband
video content from the camera to the consumer's television or remote PC and,
with a chime or email, alerts the consumer to the presence of the intruders.
This system would employ a combination of wireless, electrical and infrared
technologies and related software. This flexibility allows us to design each
product using the technology or combination of technologies best suited to
optimize the product's functions and price/performance characteristics.
Convenient and Scalable Wireless Networking Solutions. A number of the
products we offer are based on technology using the 2.4 GHz radio frequency
spectrum. This wireless broadband frequency is available for receiving and
distributing incoming video and audio signals to multiple devices within a 100-
foot radius without requiring direct line-of-sight delivery of signals. This
capability allows output from satellite and cable set-top boxes, cameras, DVD
and CD players and the Internet to be delivered to televisions, stereos and PCs
located in other rooms, although our wireless broadband communication products
do not currently allow data transfers between PCs. Because our products are
compatible with each other and can operate together, our customers can easily
expand their home and small office networks over time. Designed for
installation principally by consumers, our wireless solutions can be
implemented throughout the home or small office, in most cases, without the
need for additional telephone jacks, electrical outlets or wiring, thus
expanding the opportunities for configuration of the home or small office
network. We believe that the convenience of distributing broadband multimedia
content, accessed over the Internet, among many devices throughout the home or
small office will be a key driver in the adoption of home and small office
networking products and systems.
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Cost-Effective Products that are Easy to Install and Operate. By reducing
the cost and complexity typically associated with home networking products and
technology, we offer consumers the opportunity to easily and affordably network
their homes or small offices. Our product design and engineering expertise,
coupled with our manufacturing relationship with X10 Ltd. in China, allows us
to efficiently produce affordable, high-performance home networking solutions.
We focus our design and production capabilities on providing networking
solutions that facilitate self-installation and are compatible with a wide
array of existing electronic and electrical systems. In contrast to many other
home and small office networking products, our solutions typically do not
require costly rewiring of homes or small offices or the purchase of expensive
network-enabled devices.
Our Strategy
Our objective is to be a leading provider of affordable networking solutions
for homes and small businesses. Our strategy to accomplish this objective
includes the following key elements:
Capitalize on Our Technology. Our technology provides a low-cost,
high-performance, compatible, scalable and reliable foundation for implementing
home and small business networking applications. We design our products using a
variety of networking technologies. We are continually evaluating new and
innovative technologies as they evolve and will endeavor to incorporate new
technologies into our products as appropriate. We intend to extend our
technology by continuing to design, develop and market new broadband networking
technologies and products, allowing us to address new markets and further
penetrate existing markets.
Expand Strategic Relationships into other Distribution Channels. We,
together with X10 Ltd., intend to address new market opportunities by
continuing to develop relationships with independent contractors, sellers of
customized, bundled or private-label versions of the products we offer and
value-added resellers. We believe that the marketing, sales and distribution
capabilities of these third parties will help us market and sell our products
to a wider range of customers. We believe that collaborative relationships with
resellers and others may help us access new distribution channels, such as mass
merchants, with which these third parties may already have established
relationships. We also believe that these relationships will help us to
accelerate the acceptance by consumers of home and small office networking
technologies because consumers will have access to our products from a greater
variety of sources. We also seek to pursue and expand relationships with
leading developers and marketers of home and small office networking
technologies and leading distributors in existing and new product categories,
to establish strategic relationships with major manufacturers and service
providers and to enter into co-promotion and referral arrangements with other
e-commerce companies.
Cross-sell Products to New and Existing Customers. We believe that a
substantial number of X10-branded products have been sold for use in homes and
small offices worldwide. While virtually all of these products are based on
electrical, phoneline or infrared technologies, our exclusive license from X10
Ltd. to the X10 brand name worldwide provides us the opportunity to address
this installed base of customers. We believe that the combined benefits
resulting from the purchase of multiple products encourage consumers to
purchase additional products to extend the utility of their home or small
office networks. We seek to further penetrate the market by promoting products
that distribute broadband entertainment content throughout the home, which we
believe appeal to a broad consumer base, and subsequently to promote to those
same customers a wider range of automation and control products. We have
dedicated marketing personnel and business development programs that focus on
selling products to our existing base of customers. In 2000, approximately half
of our net revenues have consisted of sales to repeat customers. We intend to
continue to market aggressively to existing customers via our website and
customer e-mail programs. As a corollary benefit, we believe that the market
acceptance of these products evidenced by our retail Internet sales will help
to drive product acceptance by retailers and other resellers.
Provide a Compelling Value Proposition. We believe that the costs associated
with many home and small office networking products are too high for many
consumers. Accordingly, we seek to accommodate the mass markets by offering a
compelling value proposition centered around high performance and
affordability.
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Our design ingenuity, coupled with our established manufacturing relationships
with X10 Ltd. as well as X10 Ltd.'s procurement relationships, helps to
minimize production costs. Furthermore, we will continue to utilize customer
feedback, typically obtained through our website, in the design of next-
generation home networking solutions, helping us to reduce costs and to shorten
our products' time to market.
Capitalize on Relationship with X10 Ltd. We believe that our relationship
with our affiliate, X10 Ltd., provides us with a number of strategic
advantages. The products we offer are currently marketed and sold by X10 Ltd.
and X-10 (USA), which pay us variable fees and license fees on all of their
sales of our products. X10 Ltd., either directly or through its affiliates,
currently provides to us a significant level of product development, sales and
marketing support, as well as all of our manufacturing. We believe that our
relationship with X10 Ltd. allows us to take advantage of its low-cost
manufacturing and component sourcing operations on a priority basis. In
addition, we use its efficient, skilled product engineering capabilities to
speed development and reduce costs. We also seek to capitalize on the long-
standing relationships of X10 Ltd. and its affiliates with strategic retailers
and other resellers to increase sales of the products we offer.
Expand Professional Contractor Relationships. Although we believe that a
substantial majority of the products we offer are self-installed by consumers,
a segment of our customer base may prefer professional installation. As a
result, we complement our Internet sales by marketing to independent
contractors a broader suite of products than are generally available to retail
customers. These additional products can extend the functionality of a home or
small office network. We have begun to build a database of independent
contractors throughout the U.S., and we currently rely on X-10 (USA) to recruit
and train these contractors. We currently provide a referral feature on our
website that enables many consumers to select an independent contractor in
their local areas. This system also facilitates consumer feedback, which we are
using to compile a database that aggregates the performance ratings of our
independent contractors. We intend to expand this network of professional
independent contractors by aggressively marketing this referral service through
X-10 (USA) and by targeting geographic areas in which we currently do not have
representation.
Build International Presence. We believe that the increasing demand for
access to broadband content is a global phenomenon and that, as a result, there
is a significant market opportunity for the products we offer outside the U.S.
We intend to devote significant resources to adapting these products to comply
with the internal regulations of targeted countries and plan to expand our
distribution presence in strategic markets overseas.
Products
We offer affordable products, incorporating both hardware and software, that
allow consumers to network devices, systems and appliances within homes and
small offices. Our broadband products include video distribution, color camera
broadcasting and audio distribution products that we design and develop with
support from X10 Ltd. and its affiliates. These products enable users to
receive and wirelessly distribute video and audio throughout the home or small
office and distribute broadband Internet content from a PC or a satellite or
cable set-top box to televisions, stereos and other electronic entertainment
devices within a home or small office network. We also have a license to market
and sell automation and security products that are designed and manufactured by
X10 Ltd. Based primarily on electrical, infrared and phoneline technologies,
these products enable consumers to automate, control and network most
electronic devices within their homes or small offices. The products we offer
are sold through multiple channels, including our website, retail stores,
telephone orders, independent contractors and sellers of customized, bundled or
private-label products.
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The table below indicates representative products and typical applications
for various categories of broadband wireless and automation/security products:
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Representative
Product Category Products Typical Applications
<C> <C> <C> <S>
--------------------------------------------------------------------------------
VideoSENDER Delivers audio and video content
from a video output device to any
television within 100 feet
DVD Delivers wireless DVD signals from
Video Distribution Anywhere a PC or DVD player to televisions
or VCRs
B
R Big Picture Delivers audio and video signals
O from a PC to a television to enable
A big screen Internet access
D
B ----------------------------------------------------------------------------
A
N Xcam2 Transmits color video and audio
D signals wirelessly to televisions,
VCRs and PCs
W
I Color Camera XRay Vision Transmits digital images via the
R Broadcasting Internet to any remote PC
E
L ScanCam Combines Xcam2 features with a
E remote control that allows
S consumers to turn the camera on or
S off and scan between multiple
cameras
----------------------------------------------------------------------------
MP3 Delivers audio signals wirelessly
Audio Distribution Anywhere from a computer to a stereo or from
a home stereo or similar device to
a remote amplifier
--------------------------------------------------------------------------------
ActiveHome Enables consumers to remotely
control and program home lighting
Automation and appliances
C
O IR Enables consumers to control
N Commander electronic equipment from their PCs
T
R ----------------------------------------------------------------------------
O
L Protector Provides security through a system
Plus of sensors, alarms, controlled
lights and pre-recorded emergency
Security telephone messages
Monitor Provides all the benefits of
Plus Protector Plus, and enables
connection to a third-party
monitoring service
</TABLE>
--------------------------------------------------------------------------------
The products we offer are designed to be compatible, both within a product
category and across technologies, including wireless, electrical, phoneline and
infrared. We offer products as individual components, allowing consumers to
create customized networks, or in kits, each of which integrates one or more
hardware components and incorporated software into a single networking
solution. For example, our XCam2 kit includes a video camera with built-in
microphone and transmitter, video receiver and all necessary power supplies and
cables. In addition to the products identified in the table, we offer a broad
array of separate components, such as sensors, controllers and switches, that
can be integrated to create or expand a network. We believe this flexibility,
together with the broad compatibility of the products we offer, allows us to
offer consumers attractive networking solutions for homes and small offices.
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Broadband Wireless Products
Video Distribution. Our video distribution products allow customers to
deliver video signals from a device, such as a cable or satellite set-top box
or a DVD player, or from a broadband Internet video stream to virtually any
point within the home or small office, including through walls and floors. Our
video distribution products incorporate broadband wireless video transmitters
operating using the 2.4 GHz radio frequency that deliver video signals from the
video source to a wireless video receiver attached to a television, VCR or PC.
The wireless design of the products we offer allows the video signal to be
delivered within approximately a 100-foot radius, permitting viewing in a
bedroom, den, living room or other area of the home or small office.
Additionally, our programmable universal remotes, which utilize both infrared
and radio frequency wireless technologies, allow consumers to control the major
functions of various consumer electronics devices, such as televisions, DVDs,
VCRs and PCs, regardless of their location in the home or small office. Because
our video distribution products enable simultaneous video download from the
Internet and delivery to multiple viewing points in the home, as "video on
demand" becomes available through the Internet, our video distribution products
can be employed for that application as well.
Color Camera Broadcasting. Color camera broadcasting in its simplest form
involves the transmission of a video signal from a single wireless camera to a
single display device. Our wireless color camera broadcasting uses a color
image sensor to receive an image which is then transmitted using the 2.4 GHz
radio frequency over a distance of up to 100 feet to a video receiver that is
connected directly to a display device, such as a television, for remote
viewing. For example, the color camera system can be used to monitor a swimming
pool or a child's bedroom using picture-in-picture on a regular television.
Consumers can selectively view real-time video from multiple cameras using a
remote control or automatically scan from camera to camera. When used in
conjunction with a motion sensor, the system selects a designated camera when
the sensor detects motion and can also be configured to activate a lamp to
provide illumination for the camera. Our wireless color cameras can be used to
transmit digital images via the Internet to remote PCs.
Audio Distribution. Our audio distribution products can be used to deliver
multiple formats of audio signals from PCs or home stereos to remote audio
output devices. The utility of our audio distribution products has increased
with the development and acceptance of MP3 and other audio file storage formats
that enable consumers to download music from the Internet to a home computer.
Our audio distribution products deliver the audio signal using the 2.4 GHz
radio frequency directly from a home PC or stereo over a distance of up to
approximately 100 feet to a receiver, such as a stereo system or remote
amplifier, anywhere in the home. The audio source can be controlled using one
of our universal remote controls that transmits wireless signals back to the
audio source from the remote location. This feature allows remote audio program
selection and volume control.
Control Products
Automation. We offer automation networks that provide a decentralized
control system for devices and appliances that are connected to the network.
The home or small office automation network is activated by controllers that
include wired or wireless remote controls or computer interfaces. The control
software for the computer interface makes use of a graphical user interface to
facilitate the development of complex control routines. For example, our
ActiveHome software graphically depicts the control modules that have been
installed around the home or small office and directs the activities of these
modules through control signals originating from the ActiveHome graphical user
interface. As a result, a user can program home routines to run automatically,
such as an evening routine to turn on the security system, dim the lights and
gradually reduce the volume on the radio, and a morning routine to turn on the
television to the consumer's favorite program and start the coffee maker at a
specific time.
Security Systems. We offer centralized security systems that allow multiple
remote sensors to be logged into a central console located in the home or small
office for monitoring. The sensors, such as the EagleEye motion sensor, are
low-powered, battery-operated devices that transmit alarm signals in the event
of a change in the status of the environment that they are monitoring. The
security systems operate in two modes: stand-
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alone and monitored. The stand-alone systems are designed to generate a phone
call to a designated person in the event that a sensor is triggered. The
monitored systems are designed to send an alarm signal to a designated third-
party monitoring service. Additionally, the security systems will transmit
signals over powerlines to operate remote devices, such as sirens and flashing
lights within the home or small office.
Our success will depend upon the widespread demand for and acceptance of
home and small office networking products, as well as the increased use and
adoption of broadband access services. Demand for recently introduced products,
such as the products we offer, is subject to a high level of uncertainty. For a
discussion of risks related to new products, see "Risk Factors--Our success
depends in part on the continued growth of broadband access services. If these
services are not widely adopted, our sales will be adversely affected" and "--
The market for home and small office networking products is in an early stage
of development, and the products we offer may not achieve widespread
acceptance."
Technology
We offer home and small office networking solutions that incorporate
wireless, phoneline, electrical and infrared technologies. Our technologies
include wireless applications in the industrial, scientific and medical radio
frequency band at 2.4 GHz which does not require a license from the Federal
Communications Commission. We have developed software and wireless technologies
that we use in conjunction with the libraries that we have licensed from
X10 Ltd. These libraries consist of designs of integrated circuits developed
for specific applications, commonly referred to as ASICs, and printed circuit
boards as well as infrared codes. We believe that our access to these libraries
enables us to accelerate product development and introduction. We are currently
developing technology that allows data transfers among PCs.
Wireless Expertise. We believe that our expertise in wireless technologies
and our customer-oriented approach to product development enable us to develop
affordable, high-quality products. Our wireless control signals make use of the
ultra-high-frequency, band in the 310 MHz, 315 MHz, 418 MHz and 433.92 MHz
radio frequency ranges where appropriate, which enables us to provide a variety
of solutions and to adapt our products to a number of foreign markets and
select the most appropriate solution for a particular application. Our in-house
expertise in the 2.4 GHz radio frequency band enables us to develop products
specifically targeted toward broadband delivery of broadcast-quality audio and
video signals.
Software Architecture. Our software engineers have created proprietary
software programs that interoperate with multiple operating systems currently
used in the networking products we offer. We have acquired expertise in
creating Internet-related support applications for Microsoft, Linux, Solaris
and FreeBSD operating systems, which enables us to apply appropriate
technologies in an efficient manner. We target applications for remote, central
and distributed control over electronic and electrical devices, as well as the
delivery throughout the home of broadband content retrieved from the Internet.
ASIC, Printed Circuit Board and Infrared Code Libraries. We believe our
access to X10 Ltd.'s libraries of proprietary ASIC and printed circuit board
designs and infrared codes significantly increases our product design
flexibility, compatibility, scalability and speed to market. These libraries
have been developed over the course of 20 years by X10 Ltd.'s engineering and
design teams. We license these libraries from X10 Ltd. and have also applied
our expertise to the development of additions to the libraries. The ASIC
library covers designs for a broad range of functions, such as electrical,
wireless and infrared transmissions, data storage and retrieval, input device
mapping and conditional processing, that allow us to rapidly accelerate the
design process. Additionally, the printed circuit board library includes
designs for power control devices, ultra-high frequency devices, super-high-
frequency devices, infrared devices, computer interfaces, remote sensors and
low-power, battery-operated devices, enabling the creation of products with a
diverse range of applications. Furthermore, we can interoperate with our own
devices as well as a wide array of other electronic devices produced by other
manufacturers through the application of exclusively licensed infrared codes
integrated into our wireless products.
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We will not be competitive unless we continually introduce new products and
product enhancements that address changing industry standards. For a discussion
of risks associated with changing industry standards, see "Risk Factors--
Emerging industry standards may reduce the demand for our products, which will
materially harm our business."
Sales, Marketing and Customer Support
Sales. Historically, virtually all of our sales have been to retail
customers through the Internet. In the second quarter of 2000, we recognized
our first license fee revenue related to sales to retailers and other
resellers. These sales have been memorialized through purchase orders delivered
by these parties to X10 Ltd., and we received variable fees in an amount equal
to the customers' payments, net of product costs and X10 Ltd.'s fee. X-10 (USA)
originates sales to and enters into purchase order agreements with traditional
retailers, for which we receive a license fee for sales by X-10 (USA) of X10-
branded products.
We supplement our sales personnel and the sales personnel of our affiliates
with technical and product experts working at our headquarters. We believe that
products based on our owned and licensed technologies can address the market
for home and small office networking products outside of the U.S. and intend to
expand to additional foreign markets in the future. Expansion into foreign
markets involves a number of risks. For a discussion of risks associated with
our foreign expansion, see "Risk Factors--We may not successfully expand into
foreign markets or generate sufficient revenues abroad, which could impede our
growth and harm our business."
Marketing. As part of our marketing program, we seek to increase demand for
the products we offer, expand our corporate and product visibility in the
market and establish cooperative marketing programs. In addition to customer-
specific sales efforts by us and our affiliates, our marketing activities
include operation of our website, participation in trade shows, e-mail programs
and ongoing communications with our customers and the press. From time to time,
we also offer product rebates and coupons and engage in product promotions,
such as free distribution of a basic system component. These promotions are
designed to generate demand for additional related or upgrade components. As
appropriate, we may enter into cooperative marketing or development agreements
with strategic partners such as key customers, electronics manufacturers and
other home networking companies. Our ability to develop and maintain awareness
of the X10 brand is important to achieving expansion of our sales efforts and
widespread acceptance of the products we offer. For a discussion of risks
associated with our brand, see "Risk Factors--Failure to successfully promote
and maintain the X10 brand could materially and adversely affect our product
sales and business."
Customer Support. We believe that consistent, high-quality service and
support is a key factor in attracting and retaining customers. Service and
technical support is coordinated by our customer support organization in
Seattle, Washington. Our customer support organization is available via
telephone 24 hours a day, seven days a week. We rely on our affiliate, Orca
Monitoring Services, for our after-hours customer and technical support. This
organization provides customer service, telephone sales, technical support and
order processing. Customers can also access technical information about our
products through our website. We provide a one-year warranty on all of our
products. Although we have experienced limited product warranty claims in the
past, these claims could increase in the future.
Customers
Customers who buy products based on our owned and licensed technologies are
divided into four primary groups:
. Internet Customers. Through our website, consumers can access a wide
range of information about our product offerings, purchase products,
locate independent contractors for installation services, download
software and access support and technical information.
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. Customized, Bundled or Private-Label Product Resellers. We seek to
benefit from X10 Ltd.'s existing relationships with retailers and other
resellers of customized, bundled or private-label products. To date,
virtually all sales of our products to these third parties have been
made by X10 Ltd. We receive fees for products sold by X10 Ltd. that are
based on our owned technologies. We have begun to develop independent
relationships with strategic resellers, and have commenced selling
products to them directly. If we fail to expand our indirect strategic
relationships or to develop and cultivate these and other relationships
independently, or if these third parties are not successful in their
sales efforts, our sales may decrease, and our operating results may
suffer. For a discussion of risks related to distribution channels, see
"Risk Factors--If we fail to expand existing indirect distribution
channels, or to develop new ones, our business could suffer" and "--We
depend on X10 Ltd. and X-10 (USA) to sell and deliver the products we
offer to retailers and other resellers. If they fail to do so
effectively, our access to these customers would decrease, and it could
significantly harm our business."
. Retail Customers. X-10 (USA) sells X10-branded products based on our
licensed technologies to retailers in the U.S. and Canada and pays to us
a license fee based on its net sales of these products. One component of
our strategy is to develop independent relationships with these
customers, and we recently commenced selling our broadband wireless
products to one of these customers directly.
. Independent Contractors. Some of the products we offer are intended for
sale only to professionally trained contractors. Moreover, some
consumers prefer to engage professional contractors to install the
products we offer. We have developed a referral database on our website
of independent contractors, and we recently commenced selling products
to these contractors. We market products to these contractors, who then
act as independent resellers and provide installation for consumers. For
a discussion of risks related to contractors, see "Risk Factors--If we
fail to recruit a sufficient number of contractors to install the
products we offer, our strategy and results of operations could be
adversely affected."
For the nine months ended September 30, 2000, net revenues by customer
category were as follows: 78.1% Internet, 5.7% customized, bundled or private-
label product resellers, 12.4% retail and 3.8% for independent contractors.
Research and Development
We believe that timely development and introduction of new products are
essential to maintaining our competitive position. As a result, we continually
seek to refine, enhance and expand our hardware and software capabilities. We
devote most of our internal research and development resources to our wireless
technologies, control software and hardware and mechanical design. We are
committed to soliciting and understanding customer requirements. Accordingly,
purchasers of products incorporating our owned or licensed technologies are a
valued source of ideas for new products and product refinements and new market
applications for current products. We also work with X10 Ltd. and with
component suppliers to keep abreast of technological advances and to
incorporate new features as they are developed. Key elements of our research
and development strategy include:
. Core Designs. We seek to develop platform architectures and core designs
that permit cost-effective development and flexible upgrades to meet the
needs of multiple applications. These designs emphasize rapid time to
market and cost efficiency.
. Product Line Extensions. We seek to extend existing product lines
through product modifications and enhancements to meet the needs of
customers.
. Use of Industry Standard Components. Our design philosophy emphasizes
the selective use of industry standard hardware and software components
to reduce time to market, decrease the cost of goods and reduce the
risks inherent in new designs.
. New Technologies. We focus significant resources on the evaluation and
incorporation of new technologies and features as they become available.
We are currently developing technology that
46
<PAGE>
allows data transfers among PCs. We cannot assure you that we will be
successful in developing this technology or any related products, or
that these products will provide the desired functionality,
price/performance characteristics or otherwise achieve commercial
acceptance.
We perform a majority of our research and development activities in our
facilities in Seattle and outsource the detailed development to X10 Ltd. and
its affiliates under our research and development agreement with X10 Ltd.
Research and development expenses were $1,000 in 1997, $71,000 in 1998,
$712,000 in 1999 and $1.1 million for the nine months ended September 30, 2000.
The market for networking products for homes and small offices is
characterized by rapid technological developments, frequent enhancements to
existing products and new product introductions, changes in customer
requirements and evolving industry standards. To remain competitive we need to
introduce products in a timely manner that incorporate or are compatible with
these changes in our market as they emerge. For a discussion of risks related
to technological changes, see "Risk Factors--The markets in which we compete
are subject to rapid technological change, requiring us to continually design
and introduce new products. If we do not address these technological changes,
our products will become obsolete, impairing our ability to compete and
adversely affecting our business."
Manufacturing
We do not manufacture any of our own products, but instead outsource
manufacturing, assembly, testing and inspection to X10 Ltd. and its affiliates.
X10 Ltd. and its affiliates operate two factories in China and source many of
the raw materials and components used in these products from vendors in China.
We believe that our relationship with X10 Ltd. allows us to manufacture at
lower cost relative to the cost of manufacturing in the U.S. Moreover, X10
Ltd.'s familiarity with our products helps us to more rapidly respond to
customer demands, thereby increasing the flexibility and scalability of our
product manufacturing. We have entered into a 20-year, non-exclusive product
supply agreement with X10 Ltd. covering pricing, shipment and related matters.
Completed products are shipped by X10 Ltd. and its affiliates to X-10 (USA) or
another third party we designate. X-10 (USA) provides warehousing and
consignment at its Las Vegas, Nevada and Closter, New Jersey fulfillment
centers.
X10 Ltd., together with its affiliates, is currently the sole manufacturer
of our products and has limited excess manufacturing capacity. If X10 Ltd. did
not have adequate capacity at its existing facility to manufacture products for
us on a timely basis or suffered operational, production or quality assurance
difficulties, including a catastrophic event, affecting the manufacturing
facility of X10 Ltd. and its affiliates, then there could be a reduction or
disruption of manufacturing services to us. In addition, X10 Ltd.'s reliance on
single source vendors involves risks, including the possibility of shortage of
key component parts and reduced control over delivery schedules, manufacturing
capability, quality and costs. In addition some key components require long
delivery times. We cannot assure you that alternative manufacturing services
will be available to us on favorable terms or a timely basis, if at all. For a
discussion of risks related to manufacturing, see "Risk Factors--We depend on
X10 Ltd. and its affiliates to manufacture the products we offer, and if X10
Ltd. did not have adequate manufacturing capacity, we may be unable to meet
production goals or satisfy customer requirements and our business and results
of operations would be materially and adversely affected" and "--Our
manufacturer may experience shortages of supply of components for the products
we offer, which could involve substantial cost and delay and reduce the
availability of these products."
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<PAGE>
Competition
The market for networking solutions for homes and small businesses is
relatively new, rapidly evolving and intensely competitive. The broadband home
and small office networking market has received increased attention in recent
years, and a number of companies have developed competing technologies and
products for this market. In addition, a large number of companies in diverse
industries are either entering or are expected to enter the market in the near
future. We believe the principal factors on which companies compete in this
market are:
. price/performance;
. reliability;
. ease of installation and use;
. degree of product compatibility;
. breadth of product lines and introduction of new products;
. compatibility with legacy equipment and systems; and
. customer support and technical assistance.
We believe that we compete favorably with respect to these factors. However,
the pace of innovation in the markets for home and small office networks is
rapid, and we cannot assure you that the products we offer will achieve or
maintain competitiveness with available alternatives in the future. Moreover,
increased competition is likely to result in price reductions, reduced gross
margins and loss of market share, any of which could seriously harm our results
of operations.
Our current and future competitors include a broad array of public and
private companies, including home and small office network infrastructure
providers, consumer electronics companies and companies that manufacture video
cameras, intelligent appliance manufacturers and entertainment-oriented
broadband communications providers:
Home and small office network infrastructure providers. The wireless home
networking market is characterized by a multiplicity of competing standards and
protocols. We have developed technologies that operate in the 2.4 GHz radio
frequency band that allow broadband content distribution, other than data
transfers between PCs, and are based on proprietary formats that have not been
adopted by the Institute of Electrical and Electronics Engineers. Several
associations and industry groups are promoting competing standards, such as
802.11a for the faster, higher-capacity 5 GHz radio frequency spectrum, the
faster 802.11b standard for the 2.4 GHz radio frequency spectrum, Bluetooth and
HomeRF. For example, companies such as Apple, Cisco Systems, Inc., Lucent,
Cabletron Systems, Inc. and 3Com Corporation sell networking infrastructure
products based on the 802.11b standard adopted by the Institute for the 2.4 GHz
radio frequency spectrum. Other companies are developing products for the 5 GHz
radio frequency. In addition, other companies, including BreezeCom, Ltd., Cisco
Systems, Inc., Echelon Corporation, Intel, Lucent, Microsoft, Nortel Networks
Corporation, Panja Inc., Proxim, Radio Local Area Networks, Inc. and 3Com,
currently offer or are developing networks for homes and small offices. Several
of these companies offer products that enable data transfers between PCs.
Furthermore, companies such as Enikia, Inc., Intellon, Inc. and Tut Systems,
Inc. are developing phoneline and electrical products capable of 10 megabits
per second data transmission speeds. If any of these standards or protocols is
widely adopted and we do not succeed in designing products that are compatible
with those standards on a timely basis or if the compatible products we design
do not achieve market acceptance, our business and results of operations would
be adversely affected. Many of these competitors have longer operating
histories, larger customer bases, greater brand recognition and significantly
greater financial, technical, marketing and other resources than we have.
Entertainment-oriented broadband communications providers. We could face
competition from developers of products such as set-top boxes and services such
as Internet television, including Microsoft
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<PAGE>
Corporation's WebTV. These and other companies are producing broadband delivery
devices that eliminate the PC as a necessary step in the transmission of
broadband content. Broad commercial acceptance of these devices could adversely
affect sales of our PC-based broadband products and software. Furthermore, we
cannot assure you that our wireless home networking products will be compatible
with devices such as WebTV or Internet-enabled set-top boxes.
Home Control Protocols. The home automation and control products we offer
face competition from traditional home appliance manufacturers and, more
recently from high-technology companies, such as Microsoft. Microsoft and
General Electric are promoting simple control protocol, a royalty-free
networking technology to be designed for low bandwidth networks and devices
with limited memory and processing power including lights, home security
devices and other small appliances. Companies such as Domosys Corp.,
ITRAN Communications Ltd. and Mitsubishi Electric Corp. are developing simple
control protocol-enabled chips for use in smart appliances and home control
products. Broad market acceptance of appliances embedded with third-party
networking capabilities that are not compatible with the home control and
automation products we offer or that obviate the need for these products could
have an adverse impact on the market for a number of the products we offer.
Many of our competitors have longer operating histories, larger customer
bases, greater brand recognition and significantly greater financial,
technical, marketing and other resources than we have. Many of these
competitors can also devote substantially greater technical and financial
resources to product and technology development and may be better able to
exploit customer bases and other strategic relationships. In addition, large,
well-established or well-financed entities may join with our competitors or
with other companies to produce superior home networking products. Increased
competition could result in price reductions, reduced gross margins and loss of
market share, any of which could adversely affect our business and results of
operations. For a discussion of potential competition with X10 Ltd., see "Risk
Factors--We could face potential competition from X10 Ltd., which could limit
our access to sales channels, our ability to pursue business opportunities and
our ability to compete effectively."
Intellectual Property
Our success and ability to compete is dependent in part upon our proprietary
technology and information. We seek to protect our copyrights, service marks,
trademarks, trade dress and trade secrets through a combination of laws and
contractual restrictions, such as confidentiality agreements. However,
effective trademark, service mark, copyright and trade secret protection may
not be available.
We have six pending U.S. patent applications relating to our technology. X10
Ltd. has one pending patent application related to technology we license from
it. We intend to continue our efforts to identify and protect other new
inventions. While we believe that, if patents are issued as a result of these
pending patent applications, those patents would ultimately help to protect our
business, we cannot assure you that any of these patents will issue, or that
any issued patents will protect our intellectual property. In addition, it is
possible that any issued patents or pending applications could become involved
in an interference or reexamination proceeding. In addition, other parties may
independently develop similar or competing technologies not covered by any
patents that may issue.
Third parties may assert direct, indirect or contributory copyright,
trademark or other intellectual property infringement or contractual claims or
unfair competition claims against us. The law in many of these areas is
uncertain and we cannot predict whether our customers will operate our products
in accordance with applicable laws or agreements or whether any of the claims
will harm our business. We may receive in the future notices of claims of
infringement of other parties' intellectual property rights. For example, we
are aware of a notice of a claim of infringement received by X-10 (USA)
alleging that the telephone responder product we offer, used to remotely
control home appliances via powerline signals initiated through a telephone,
infringes upon a third party's patent related to touch-tone operated control
devices. Defending against this or any other potential claims could result in
protracted and costly litigation, regardless of the merits of those claims, and
any dispute
49
<PAGE>
could require us to pay damages, develop non-infringing technology or enter
into royalty or licensing agreements. We cannot assure you that any necessary
licenses would be available or that, if available, these licenses could be
obtained on commercially reasonable terms. In addition, the steps we take to
protect the intellectual property rights that we own or license may be
inadequate. For discussion of risks related to intellectual property, see "Risk
Factors--If the technology and intellectual property we own or license were
inadequately protected, our business and reputation could be harmed and we
could lose a valuable asset" and "--Direct, indirect or contributory
intellectual property infringement or related claims against us could be costly
and time consuming to defend, divert management attention, preclude sales of
the products affected and reduce our revenues."
Governmental Regulation
Many of the products we offer and the home and small office networking
industry in which they are used are subject to federal and international
regulation. In addition, industry and consumer groups may promote and
independently adopt standards and protocols, any of which could achieve wide
acceptance. From time to time, the regulatory entities that have jurisdiction
over our business may adopt new or modified regulations or take other actions
on their own regulatory initiatives or at the request of industry, consumers,
other branches of government or in response to changes in laws. This changing
regulatory environment could adversely affect the nature and extent of products
we are able to offer. In addition, the occurrence of regulatory changes,
including changes in the allocation of available license-free radio frequency
spectrum or technical requirements for its use, could significantly affect our
operations by rendering current products obsolete, restricting the applications
and markets served by our wireless products or increasing the opportunity for
additional competition.
On the federal level, the FCC regulates our products. We cannot assure you
that we will be able to secure the necessary certifications required by the FCC
for the products that we intend to introduce in the future. The need to obtain
these certifications could result in delays or additional costs.
Our wireless products share the 2.4 GHz radio frequency band, which does not
require a license from the FCC, with other users. There are other users in the
band that have priority over our use, and the FCC requires that we not cause
harmful interference to those users. In the event that there is interference
between those users and us, those users can require that we curtail
transmissions that create interference. In this spectrum, we operate on a co-
equal basis with other non-priority users and must accept any interference
present in the frequency band. If users of our products experience excessive
interference from licensed users or other non-priority users, market acceptance
of our products could be adversely affected, which could materially and
adversely affect our business and results of operations.
We may desire or, as a result of changes in regulations, be required to seek
to operate in other license-free frequency bands. Redesigning our products to
operate in other frequency bands could be very expensive and time-consuming,
and we cannot assure you that any redesigned products would receive
certifications required by the FCC or would be commercially viable.
To the extent that our products are sold in markets outside the U.S., our
products are also subject to regulatory requirements in international markets.
One component of our business strategy is to expand our international presence
and, as a result, we must monitor the development of radio frequency
regulations in countries that represent potential markets for our products.
Changes in, or our failure to comply with, applicable international regulations
could materially and adversely affect our ability to implement our strategy, as
well as our business and results of operations.
Employees
As of October 31, 2000, we had 51 employees, including eight in research and
development, two in operations, nine in sales and marketing, 23 in customer
service and training and nine in administration. None of our employees is
represented by a labor union or subject to a collective bargaining agreement.
We have not experienced any work stoppages and consider our employee relations
to be good.
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Facilities
We occupy on a month-to-month basis approximately 6,000 square feet of
office space in Seattle, Washington, leased by Orca Monitoring Services, an
affiliate of X10 Ltd. We anticipate our total rental expense will be
approximately $72,000 during fiscal 2000. We anticipate that we will need to
relocate to a larger facility shortly after completion of this offering to meet
our anticipated growth needs. We believe, based on current market availability,
that suitable additional space will be available as needed.
Legal Proceedings
In June 2000, Egghead.com, Inc. filed a complaint against us in Spokane
County Superior Court in the state of Washington seeking approximately $175,000
in monies due relating to advertising services, plus interest, costs and
attorney's fees. We filed an answer to the complaint in September 2000.
Settlement negotiations are ongoing relating to this matter. We may from time
to time be a party to additional legal proceedings or governmental or
administrative actions.
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MANAGEMENT
Executive Officers and Directors
The following table identifies our executive officers and directors as of
October 31, 2000:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
George E. Stevenson...... 58 Chairman of the Board and Chief Executive Officer
Alexander E. Peder....... 41 President and Director
Wade A. Pfeiffer......... 33 Chief Financial Officer
James R.W. Phillips...... 31 Chief Technology Officer and Director
C. Gregory Amadon(1)(2).. 48 Director
Bernard S. Appel(1)...... 68 Director
William T. Baxter(1)(2).. 37 Director
Hin Chew Chung........... 48 Director
</TABLE>
----------
(1) Member of our audit committee.
(2) Member of our compensation committee.
George E. Stevenson has served as our chairman of the board since July 2000
and has served in the capacity of chief executive officer since our inception.
Mr. Stevenson is the founder, president and a director of our affiliate, X10
Ltd., a Hong Kong-based company which, together with its affiliates, designs
and manufactures home controls, entertainment and security technology products.
He has served as the president of X10 Ltd. since 1978 and serves in the
capacity of an officer and director of several of its affiliated companies and
subsidiaries. Mr. Stevenson is not employed by us.
Alexander E. Peder has served in the capacity of president and as a director
since August 1999. From July 1996 to August 1999, Mr. Peder served as president
of retail sales, one of three divisions of X-10 (USA), a wholly owned
subsidiary of X10 Ltd. that provides sales, marketing and product distribution
services for X10 Ltd. in the U.S. From June 1994 to July 1996, Mr. Peder served
as vice president of worldwide sales at Virtual i-O, Inc., a systems
development and manufacturing company. Virtual i-O filed a bankruptcy petition
under Chapter 11 of the U.S. federal bankruptcy laws in February 1997.
Wade A. Pfeiffer has served in the capacity of chief financial officer since
July 1999. Mr. Pfeiffer also served as a director from August 1999 to July
2000. From January to July 1999, Mr. Pfeiffer was director of finance and
operations for Definitive Stock, Inc., an online stock photography agency. From
1986 to 1998, Mr. Pfeiffer served in various positions with Ernst & Young llp,
most recently as a senior manager in the corporate finance division.
James R.W. Phillips has served in the capacity of chief technology officer
since our inception and has served as a director since July 2000. From 1994 to
1998, Mr. Phillips served as director of software engineering at System X-10,
Ltd., a wholly owned subsidiary of X10 Ltd. Mr. Phillips is currently employed
by X-10 (USA) and not by us.
C. Gregory Amadon has served as a director since July 2000. In December
1997, Mr. Amadon founded TeraBeam Networks, Inc., a fiberless optical network
service company. From March to September 2000, Mr. Amadon served as TeraBeam's
chairman, chief technology officer and chief development officer. From December
1997 to March 2000, he served as its chairman, president and chief executive
officer. From January 1997 to November 1997, Mr. Amadon was an independent
investor. Mr. Amadon was co-founder of Virtual i-O and served as its chief
executive officer from May 1993 to January 1997. Virtual i-O filed a bankruptcy
petition under Chapter 11 of the U.S. federal bankruptcy laws in February 1997.
Bernard S. Appel has served as a director since October 2000. Mr. Appel
founded Appel Associates, a privately held marketing and consulting company, in
July 1993 and has served as its President since that time.
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Prior to that time, Mr. Appel served in various positions with RadioShack
Corporation, including President and Chairman, and as Senior Vice President of
Tandy Corporation. Mr. Appel is a director of uniView Technologies Corporation.
William T. Baxter has served as a director since July 2000. Mr. Baxter was a
co-founder of BSQUARE Corporation, a software company providing operating
systems and integration software headquartered in Bellevue, Washington, and has
served as its president, chief executive officer and chairman of the board
since its inception in July 1994.
Hin Chew Chung has served as a director since July 2000. Since 1989, Mr.
Chung has served as chairman of our affiliate, X10 Ltd. Mr. Chung currently
serves as chairman of Zhongli Investment Pte. Ltd., his privately held
investment company based in Singapore.
There are no family relationships among any of our directors or executive
officers.
Mr. Stevenson's and Mr. Chung's positions at X10 Ltd. could create real or
apparent conflicts of interest in the event that they are faced with decisions
that could have different implications for X10 Ltd. and us. These decisions may
relate to corporate opportunities, corporate strategies, potential acquisitions
of businesses, the intercompany agreements, competition, the issuance or
disposition of securities, the election of new or additional directors and
other matters. In addition, James Phillips, our chief technology officer, is an
employee of X-10 (USA) and works for us on a contract basis. We cannot assure
you that the information Mr. Phillips learns in his capacity as our chief
technology officer will be kept confidential from X10 Ltd. or X-10 (USA). For a
discussion of risks related to potential conflicts of interests, see "Risk
Factors--Some of the key management personnel on whom we depend are also
management personnel or employees of X10 Ltd. or its affiliates, which could
create conflicts of interest between X10 Ltd. or its affiliates and us."
Board Composition
Upon completion of this offering, our board will consist of seven directors
divided into three classes. At each annual meeting of stockholders, directors
will be elected by the holders of common stock for terms of three years to
succeed the directors whose terms are expiring. We anticipate that upon
completion of this offering, Bernard Appel, Alexander Peder and James Phillips
will serve as Class I directors with terms expiring in 2001, Hin Chew Chung and
Gregory Amadon will serve as Class II directors with terms expiring in 2002 and
William Baxter and George Stevenson will serve as Class III directors with
terms expiring in 2003. Any additional directorships resulting from an increase
in the number of directors will be distributed among the three classes so that,
as nearly as possible, each class will consist of one-third of the directors.
Classification of the board of directors could delay, deter or prevent changes
in our control or management. In addition, our directors may be removed from
the board only for cause. For a discussion of risks related to anti-takeover
measures, see "Risk Factors--Provisions of our amended and restated certificate
of incorporation and bylaws could delay, deter or prevent a third party from
acquiring us even if doing so would be beneficial to our stockholders."
Board Committees
Our board of directors has an audit committee and a compensation committee.
The audit committee meets with our independent auditors as necessary to review
the results of the annual audit. The audit committee also reviews and evaluates
our accounting, auditing and reporting practices, including audit and control
functions, serves as a focal point for communication between non-committee
directors, the independent accountants and our management, and monitors
transactions between us and our affiliates, including X10 Ltd. and X-10 (USA),
our employees, officers and directors, or any of their affiliates. The
compensation committee has authority to set, review and approve the
compensation levels of and policies for officers and employees; propose the
adoption, amendment and termination of employee benefit plans; provide reports
of our compensation policies for our proxy or information statements; and
administer our stock option and stock purchase plans. The board
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<PAGE>
has delegated authority to our chief executive officer, George Stevenson, to
grant options under the 2000 Equity Incentive Plan within specified limitations
to persons other than our officers or directors. The audit committee is
composed of Gregory Amadon, Bernard Appel and William Baxter. The compensation
committee is composed of Gregory Amadon and William Baxter.
Compensation Committee Interlocks and Insider Participation
Prior to this offering, our board of directors did not have a compensation
committee and all compensation decisions relating to our executive officers
were made by Mr. Stevenson, our chief executive officer, together with our
board of directors. Upon completion of this offering, it is anticipated that
the compensation committee will make all compensation decisions regarding our
executive officers. During 1999, Mr. Stevenson was a member of X10 Ltd.'s board
of directors and controlled all compensation-related decisions. During 1999,
Mr. Stevenson purchased shares of our common stock and X10 Ltd. engaged in a
number of transactions with us. For a description of these transactions, see
"Certain Transactions and Business Relationships."
Compensation of Directors
We currently do not provide our directors with cash compensation for their
services as members of our board of directors, although directors are
reimbursed for reasonable expenses incurred in connection with attendance at
board and committee meetings. Directors are eligible to participate in our 1999
Stock Plan and 2000 Equity Incentive Plan. Messrs. Baxter, Amadon and Appel
have each been granted options, effective upon the date of this prospectus, to
purchase 80,000 shares of our common stock at an exercise price equal to 70% of
the initial public offering price. The options vest over two years at a rate of
25% every six months. In addition, for every six months of continuous service,
each of these non-employee directors will be granted options under our 2000
Equity Incentive Plan to purchase 20,000 shares of our common stock at an
exercise price equal to 100% of the fair market value of our common stock on
the dates of the grants. These options will vest over two years at a rate of
25% every six months.
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<PAGE>
Executive Compensation
The following table sets forth the compensation awarded, paid, earned or
accrued for services rendered to us in all capacities during 1999 to our chief
executive officer and our other executive officers. We refer to these officers
as our named executive officers in other parts of this prospectus. In
accordance with SEC rules, the compensation described in the table does not
include medical, group life insurance or other benefits that are available
generally to all our salaried employees or perquisites and other personal
benefits that do not exceed the lesser of $50,000 or 10% of the officer's total
salary and bonus.
Summary Compensation Table
<TABLE>
<CAPTION>
Long-Term
Compensation
------------
Awards
Annual Compensation ------------
--------------------------------------- Securities
Name and Principal Other Annual Underlying
Position Salary ($) Bonus ($) Compensation ($) Options(#)
------------------ ---------- --------- ---------------- ------------
<S> <C> <C> <C> <C>
George E. Stevenson...... -- (1) -- -- (2) 600,000
Chief Executive Officer
Alexander E. Peder....... $130,000 -- -- 200,000
President
Wade A. Pfeiffer......... 60,000(3) $10,000 -- 350,000
Chief Financial Officer
James R.W. Phillips...... 120,000 -- $12,000(4) 200,000
Chief Technology Officer
</TABLE>
----------
(1) Does not include an annual management service fee paid by X10 Ltd. to Mr.
Stevenson's personal management company, which fee was $264,000 for the
fiscal year ended December 31, 1999.
(2) Does not include amounts relating to 5,050,000 shares of our common stock
purchased at $0.001 per share by Mr. Stevenson on October 1, 1999, as
described in "Certain Transactions and Business Relationships--Sales of
Securities."
(3) Mr. Pfeiffer has served in the capacity of chief financial officer since
July 1999. His annual salary is $120,000.
(4) Represents the annual cost of an automobile leased by us for Mr. Phillips'
benefit.
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<PAGE>
Option Grants
The following table sets forth information concerning stock options granted
to our named executive officers during 1999.
Option Grants in Last Fiscal Year
<TABLE>
<CAPTION>
Individual Grants
-----------------------------------------------------------
Percent of
Total Potential Realizable Value at
Number of Options Deemed Assumed Annual Rates of
Securities Granted to Value Per Stock Price Appreciation for
Underlying Employees Share for Option Term ($)(4)
Options in Fiscal Exercise Date of Expiration ----------------------------------
Name Granted (#)(1) Year (%)(2) Price ($) Grant($)(3) Date 0% 5% 10%
---- -------------- ----------- --------- ----------- ---------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
George E. Stevenson..... 600,000 41.4% $0.001 $2.49 10/1/09 $8,999,400 $14,659,069 $23,342,124
Alexander E. Peder...... 200,000 13.8 0.001 2.49 10/1/09 2,999,800 4,886,358 7,780,708
Wade A. Pfeiffer........ 350,000 24.1 0.001 2.49 10/1/09 5,249,650 8,551,124 13,616,239
James R.W. Phillips..... 200,000 13.8 0.001 2.49 10/1/09 2,999,800 4,886,358 7,780,708
</TABLE>
----------
(1) The options in the table were granted under our 1999 Stock Plan. We have
not granted any stock appreciation rights. All of these options are
nonstatutory stock options, granted at an exercise price below the fair
value per share on the date of grant. Each option vests and becomes
exercisable in 12.5% increments every six months from the date of grant.
(2) We granted options to purchase 1,450,000 shares of our common stock to
employees and consultants in 1999.
(3) The deemed value for the date of grant was determined after the date of
grant solely for financial accounting purposes.
(4) The potential realizable values are net of exercise price, but before
taxes associated with exercise. Amounts represent hypothetical gains
calculated by:
. multiplying the number of shares subject to the option by an assumed
initial public offering price of $15.00 per share;
. assuming that the total share value derived from that calculation
appreciates at the indicated rates, compounded annually, for the entire
term of the option; and
. assuming that the option is exercised and sold on the last day of its
term at the appreciated price.
The assumed 0%, 5% and 10% rates of stock price appreciation are provided
in accordance with rules of the SEC and do not represent our estimate or
projection of the future common stock price. The assumed rate of 0%
indicates the assumed initial public offering price less the exercise
price.
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<PAGE>
Options Exercised and Fiscal Year-End Option Values
The following table sets forth the number of shares underlying options held
by our named executive officers and the value of their unexercised in-the-money
options at fiscal year end, based on an assumed initial public offering price
of $15.00 per share, less the exercise price payable for these shares. None of
our named executive officers exercised options in 1999.
Aggregated Option Exercises in Last Fiscal Year
and Fiscal Year-End Option Values
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options at
Value Options at Fiscal Year End (#) Fiscal Year End ($)
Shares Acquired Realized ------------------------------ -------------------------
Name on Exercise (#) ($) Exercisable/Unexercisable Exercisable/Unexercisable
---- --------------- -------- ------------------------------ -------------------------
<S> <C> <C> <C> <C>
George E. Stevenson..... 0 0 0/600,000 $0/$8,999,400
Alexander E. Peder...... 0 0 0/200,000 0/2,999,800
Wade A. Pfeiffer........ 0 0 0/350,000 0/5,249,650
James R.W. Phillips..... 0 0 0/200,000 0/2,999,800
</TABLE>
Employee Benefit Plans
2000 Equity Incentive Plan
Our 2000 Equity Incentive Plan was adopted by our board of directors in July
2000. It will become effective upon completion of this offering. The incentive
plan provides for the grant of incentive stock options to employees and
nonstatutory stock options, stock bonuses and restricted stock awards to
employees, directors and consultants.
A total of 3,000,000 shares of common stock have been authorized for
issuance under the incentive plan. As of the date of this prospectus, no shares
or options have been issued under the incentive plan. In July and October 2000,
we authorized the issuance of nonstatutory stock options to purchase an
aggregate of 240,000 shares of our common stock to our non-employee directors.
Shares subject to options that have terminated without having been exercised in
full become available again for issuance under the incentive plan. An annual
increase in the share reserve will be added on each January 1st beginning in
2002, equal to the lowest of:
. 1,500,000 shares;
. 5% of the outstanding shares of our common stock on that date; or
. a lesser amount determined by the board of directors.
Our board of directors or a committee thereof will administer the incentive
plan and will determine the terms of options granted, including the exercise
price, the number of shares subject to individual option awards and the vesting
period of options. The exercise price of incentive stock option grants cannot
be lower than 100% of the fair market value on the date of grant and, in the
case of incentive stock options granted to employees who are holders of more
than 10% of our voting power, not less than 110% of the fair market value.
Unless otherwise approved by the board, the exercise price of nonstatutory
stock options may not be less than 85% of the fair market value on the date of
grant. The aggregate fair market value determined at the time of grant of the
shares of common stock for which incentive stock options are exercisable for
the first time by an optionholder during any calendar year may not exceed
$100,000. The term of an incentive stock option or a nonstatutory stock option
cannot exceed 10 years, and the term of an incentive stock option granted to a
holder of more than 10% of our voting power cannot exceed five years. Options
may, but need not, permit early exercise of the option so long as the
optionholder enters into an agreement providing for a repurchase option in our
favor with respect to unvested shares. The terms of stock bonus awards and
restricted stock awards are determined by the board or a committee of the
board. Stock bonus awards and restricted stock awards may, but need not, be
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subject to a share repurchase option in our favor in accordance with a vesting
schedule determined by the board. Options and other awards granted under our
incentive plan become exercisable at rates determined by the board.
The incentive plan provides that, if we are acquired in a merger or asset
purchase or if we otherwise undergo a change in control, the successor
corporation will assume or substitute an equivalent option for each outstanding
option under the incentive plan. If the successor corporation refuses to assume
or substitute options or awards, however, the options and awards will become
fully vested and exercisable. We may grant awards that provide for full vesting
of an optionholder's options following a merger or acquisition if the successor
corporation terminates the optionholder's status as an employee or consultant
other than for cause within 12 months following such merger or acquisition.
These provisions may have the effect of delaying, deterring or preventing
potential changes in our control. The board of directors may amend the
incentive plan at any time, subject in some instances to stockholder approval,
so long as the amendment does not impair the rights of optionholders without
their consent. The incentive plan will terminate in July 2010, unless
terminated earlier in accordance with its terms.
2000 Employee Stock Purchase Plan
Our 2000 Employee Stock Purchase Plan was adopted by our board of directors
in July 2000. It will become effective upon completion of this offering. The
purchase plan provides our employees with an opportunity to purchase our common
stock through accumulated payroll deductions. A total of 350,000 shares of
common stock has been authorized for issuance under our purchase plan, none of
which has been issued prior to this offering. An annual increase in the share
reserve under the purchase plan will be added on each January 1, beginning in
2002, equal to the lowest of:
. 250,000 shares;
. 1% of the outstanding shares of our common stock on that date; or
. a lesser amount determined by the board of directors.
The purchase plan will be administered by our board of directors or by a
committee appointed by the board of directors. The purchase plan will permit
eligible employees to purchase common stock through payroll deductions of up to
15% of an employee's base compensation, as defined in the plan, during the
offering period. The price at which common stock will be purchased under the
purchase plan will be equal to 85% of the fair market value of our common stock
on the first day of the applicable offering period or the last day of the
applicable purchase period, whichever is lower. No employee may purchase more
than $25,000 worth of stock, determined at the fair market value of the shares
at the time the right is granted, in any calendar year. Generally, employees,
other than holders of 5% or more of our common stock, employed by us at least
20 hours per week and five months per calendar year are eligible to participate
in the purchase plan. Employees eligible on a given enrollment date can
participate during that offering period, provided they remain employed by us
for the duration of that offering period.
Unless the board of directors or its committee determines otherwise, the
purchase plan will be implemented in a series of offering periods, each
approximately 12 months in duration, containing consecutive six-month purchase
periods. The first offering period will commence on the date on which the
registration statement of which this prospectus is a part is declared effective
by the SEC and will terminate on October 31, 2002. If we are acquired and the
acquiring corporation refuses to assume all existing rights, offering and
purchase periods then in progress will be shortened and all rights
automatically exercised.
Employees may end their participation in the offering at any time, and
participation automatically ends on termination of employment. The board of
directors may amend the purchase plan at any time, subject in some instances to
stockholder approval, as long as the amendment does not impair rights of plan
participants without their consent. The purchase plan will terminate in July
2010, unless terminated earlier in accordance with its terms.
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1999 Stock Plan
Our 1999 Stock Plan was adopted by our board of directors in October 1999
and subsequently approved by our stockholders. The 1999 plan provides for the
grant of incentive stock options to employees and nonstatutory stock options
and stock purchase rights to our employees, directors and consultants. A total
of 3,500,000 shares of common stock has been authorized for issuance under the
1999 plan. Upon completion of this offering, the 1999 plan will terminate and
no additional options will be granted under the 1999 plan. Shares subject to
outstanding options under the 1999 plan will continue to be governed by the
1999 plan. Shares reserved but not granted under the 1999 plan will revert to
the status of authorized, unissued and unreserved shares of our common stock.
As of September 30, 2000, nonstatutory stock options to purchase 1,450,000
shares of common stock were outstanding and 2,050,000 shares were available for
future grant.
The 1999 plan permits the grant of options to employees, officers, directors
and consultants. Our board of directors or its compensation committee
administers the 1999 plan and has determined the terms of options granted,
including the exercise prices, the number of shares subject to individual
options and the vesting period of the options. Nonstatutory options granted to
employees, consultants or directors have exercise prices as determined by the
administrator. Options granted under our 1999 plan generally become exercisable
in 12.5% increments every six months from the date of grant. The 1999 plan
provides that, in the event we are acquired in a merger or asset purchase, the
successor corporation will assume or substitute an equivalent option for each
outstanding option under the 1999 plan. If the successor corporation refuses to
assume or substitute options, all outstanding options under the 1999 plan will
become fully vested and be exercisable for a period of 15 days from the date of
notice that the options or other stock purchase rights will not be assumed by
the successor corporation. The board of directors may amend, suspend or
terminate the 1999 plan at any time as long as the amendment or termination
does not impair the rights of optionholders without their consent.
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CERTAIN TRANSACTIONS AND BUSINESS RELATIONSHIPS
Sales of Securities
Since our incorporation on July 29, 1999, we have issued and sold securities
in the following transactions to directors, executive officers and holders of
more than 5% of our common stock.
Purchase by X10 Ltd. On October 1, 1999, we issued 10,000,000 shares of our
common stock to X10 Ltd. These shares were issued in consideration of the
assignment to us of intellectual property, the execution and delivery of the
amended and restated bill of sale and assignment, amended and restated license
agreement, and amended and restated product supply agreement and in full
payment of a promissory note in the principal amount of $1,024,300 issued by us
to X-10 (USA) and assigned by X-10 (USA) to X10 Ltd., its parent company. The
consideration for the shares we issued was determined by our board of directors
to be fair value for the shares. Mr. Stevenson and Mr. Chung are both directors
and significant beneficial owners of shares of X10 Ltd.
Purchases by George Stevenson and Hin Chew Chung. On October 1, 1999, we
issued 5,050,000 shares of our common stock to George Stevenson, our chief
executive officer and chairman of the board, at a price per share of $0.001,
for an aggregate purchase price of $5,050. On the same date, we issued
5,000,000 shares of our common stock to Hin Chew Chung, one of our directors,
at a price per share of $0.001, for an aggregate purchase price of $5,000. Both
purchases were made pursuant to stock subscription agreements, and each party
paid for his stock with a promissory note, bearing interest at the rate of 7.0%
per year. In May 2000, Mr. Stevenson paid approximately $5,256 to us, and in
May 2000, Mr. Chung paid approximately $5,204 to us, each in full repayment of
the amounts outstanding under their notes.
On October 1, 1999, Mr. Stevenson made gifts of or sold 2,050,000 of his
shares of our common stock to several individuals, including 300,000 shares to
Alexander Peder, our president and a director, 50,000 shares to Wade Pfeiffer,
our chief financial officer, and 300,000 shares to James Phillips, our chief
technology officer and a director. Messrs. Peder, Pfeiffer and Phillips
purchased their shares from Mr. Stevenson at a price per share of $0.40, the
fair value as determined by our board as of that date and based upon an
independent valuation, and each officer paid for his shares with a full
recourse promissory note due October 1, 2002, bearing interest at the rate of
7.0% per year. The promissory notes are secured by a pledge of each officer's
purchased shares.
Intercompany Relationships
We have entered into a number of agreements and transactions with companies
affiliated with our directors, officers and 5% stockholders. None of these
agreements or transactions was negotiated at arm's length. Currently, X10 Ltd.
and its affiliates are our sole providers of manufacturing and product
development services and market our products to sellers of customized, bundled
or private-label products. Similarly, X-10 (USA) is our sole provider of order
fulfillment services and sole seller of X10-branded products to retailers and
other resellers. None of these agreements requires us to use X10 Ltd. or X-10
(USA) exclusively. In most cases, the only remedy specified for breach or
default by X10 Ltd. or X-10 (USA) under these agreements is termination of the
agreements. If any of these agreements were to terminate, our ability to
manufacture the products we offer, fulfill customer orders, penetrate the
retail and other reseller markets and efficiently perform some aspects of our
product development process would be impaired, product production and delivery
would be delayed, our net revenues would decrease and our costs of operations
would increase, any of which would adversely effect our business and results of
operations. For a discussion of risks related to the intercompany agreements,
see "Risk Factors--We depend on X10 Ltd., X-10 (USA) and other affiliates of
X10 Ltd. to provide substantially all of our manufacturing and fulfillment
services, to sell and distribute products to retailers and other resellers and
to provide product development services" and "--Our agreements with X10 Ltd.
and X-10 (USA) were not the result of arm's length negotiations and could
subject us to less favorable terms than we otherwise could have obtained from
other third parties."
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Transactions with X10 Ltd. and its Affiliates
We have entered into the following agreements and transactions with X10
Ltd., one of our significant stockholders. X10 Ltd. is controlled by George
Stevenson, our chief executive officer, chairman of the board and a significant
stockholder, and Hin Chew Chung, one of our directors and a significant
stockholder.
Amended and Restated Bill of Sale and Assignment. We have entered into an
amended and restated bill of sale and assignment under which X10 Ltd. sold and
assigned to us technology and intellectual property relating to our broadband
wireless products. This agreement was partial consideration for the issuance of
10,000,000 shares of our common stock to X10 Ltd., together with the assignment
to us of intellectual property, the execution and delivery of the amended and
restated license agreement and the amended and restated product supply
agreement and in full payment of a promissory note in the principal amount of
$1,024,300 issued by us to X-10 (USA) and assigned by X-10 (USA) to X10 Ltd.
Based upon an assumed initial public offering price of $15.00, the fair value
of the shares issued for the aggregate consideration listed above was $150.0
million.
Intellectual Property License. We have entered into an amended and restated
license agreement under which X10 Ltd. has granted to us a perpetual right to
use, design, develop, make, manufacture, market, sell and distribute all
existing and future phoneline, infrared and electrical products owned by
X10 Ltd. The agreement provides that these rights are exclusive to us, on a
worldwide basis, except for sales of non-branded products by X10 Ltd. to
original equipment manufacturers and sellers of customized, bundled or private-
label products. We also received the exclusive, perpetual right, on a worldwide
basis, to use the copyrights, trade names, trade dress, trademarks and service
marks owned by X10 Ltd. related to the "X10" mark, in the marketing, sale and
distribution of our products and the products subject to the license. The
license expires on December 31, 2019, unless renewed for subsequent five-year
terms at our option.
Product Supply Relationship. We have entered into an amended and restated
product supply agreement under which X10 Ltd. has agreed to manufacture, at our
direction, broadband wireless and phoneline, infrared and electrical products,
and to ship the products on consignment to a warehouse designated by us,
currently X-10 (USA). We are obligated to purchase the products on the earlier
of receipt of a purchase order from a customer or 120 days from delivery of the
products by X10 Ltd. to the shipper. Under the agreement, we pay X10 Ltd. a fee
for the products equal to X10 Ltd.'s costs to produce the products. This
agreement expires on December 31, 2019, unless renewed for subsequent five-year
terms at our option. In the event of a breach or default by X10 Ltd. under this
agreement, we have a contractual right to setoff any amounts owed by us against
any losses resulting from the breach or default. The total fees paid or payable
by us to X10 Ltd. for these services from inception through December 31, 1997,
were $56,000, for the fiscal year ended December 31, 1998, were $1.1 million,
for the fiscal year ended December 31, 1999, were $10.5 million, and for the
nine months ended September 30, 2000, were $13.7 million.
Research and Development Relationship. We have entered into an amended and
restated research and development services agreement with X10 Ltd. under which
X10 Ltd. has agreed, at our direction, to conduct research and development for
the design and production of our wireless products; to submit estimates of
costs required to develop prototypes and manufacture the products; to determine
all necessary or appropriate production standards and licensing requirements;
and to provide specifications for and produce workable prototypes. Under the
agreement, we pay a service fee in connection with the development of each
product as established by X10 Ltd. This agreement expires on December 31, 2019,
unless renewed for subsequent five-year terms at our option. From our inception
through March 31, 2000, we did not pay X10 Ltd. any fees related to research
and development services. During the nine months ended September 30, 2000,
total fees paid or payable to X10 Ltd. related to research and development were
$450,000.
Contract Manufacturing Agreement. We have entered into a contract
manufacturing agreement with X10 Ltd. under which X10 Ltd. will pay to us a
variable fee based on X10 Ltd.'s sales of our wireless products to original
equipment manufacturers and sellers of customized, bundled or private-label
products and on sales of electrical products to these third parties that we
introduce to X10 Ltd. Under this agreement, our fee is equal
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to the net sales price of the products sold by X10 Ltd., less costs and a
manufacturing fee retained by X10 Ltd. This manufacturing fee is equal to 15%
of the net sales price of each product sold until aggregate sales of that
product reach $2,000,000 and 10% of the net sales price of each product
thereafter. X10 Ltd. is required to sell the products on the same terms and
conditions that we have previously negotiated. Total fees paid or payable to us
by X10 Ltd. under this agreement during the nine months ended September 30,
2000, were $1.2 million. In addition, we also have the right to sell products
directly to these customers, for which we pay a fee to X10 Ltd. equal to the
actual costs of manufacturing and shipping the products. This agreement expires
April 1, 2005, and will automatically be renewed for subsequent five-year terms
unless terminated by either party.
Transactions with X-10 (USA) Inc.
The following agreements and transactions were entered into with X-10 (USA),
a wholly owned subsidiary of X10 Ltd.:
Amended and Restated Asset Purchase Agreement. We have entered into an
amended and restated asset purchase agreement with X-10 (USA) under which X-10
(USA) transferred to us all right and title to specified universal resource
locators, or URLs, domain names and website names, as well as all customer,
vendor and supplier lists, and sales, product and promotional literature or
aids used in connection with those assets. In exchange, we issued a promissory
note to X-10 (USA) in the principal amount of $1,024,300, which was
subsequently assigned to X10 Ltd. The note was canceled in partial
consideration of our issuance to X10 Ltd. of 10,000,000 shares of our common
stock. We also assumed approximately $1,183,000 of specific liabilities of
X-10 (USA), related to the assets acquired, in consideration of which
X-10 (USA) has issued to us a promissory note in the principal amount of
$1,183,000, payable on or before September 30, 2001, and bearing interest at
the rate of 8.0% per year. As of September 30, 2000, this promissory note was
paid in full. The value of the transferred assets was determined by our board
of directors on the basis of an independent valuation obtained in connection
with the sale.
Fulfillment Services Relationship. We have entered into an amended and
restated fulfillment services agreement with X-10 (USA), under which X-10 (USA)
has agreed to warehouse and ship products manufactured for us by X10 Ltd. and
other manufacturers. Under the agreement, X-10 (USA) ships products to our
customers in accordance with fulfillment orders that we submit to X-10 (USA)
from time to time. We pay a fee in connection with these services equal to 10%
of our gross receipts for the products shipped, excluding sales and other
taxes. This agreement expires December 31, 2004, unless renewed for subsequent
five-year terms at our option. Fulfillment service fees paid or payable by us
to X-10 (USA) from inception through December 31, 1997, were $10,000, for the
fiscal year ended December 31, 1998, were $297,000, for the fiscal year ended
December 31, 1999, were $1.1 million, and for the nine months ended September
30, 2000, were $2.2 million.
Amended and Restated Sublicense Agreement. We have entered into an amended
and restated sublicense agreement with X-10 (USA), under which we have granted
X-10 (USA) a non-exclusive sublicense to market, sell and distribute in the
western hemisphere electrical products licensed to us by X10 Ltd., as well as
any new products we select. The sublicense is limited to sales of X10-branded
products to resellers, other than original equipment manufacturers and
resellers of customized, bundled or private-label products. Under the
agreement, X-10 (USA) pays us a quarterly license fee of 15% of its net sales
of licensed products, or a minimum license fee, whichever is greater. The
minimum license fee is $250,000 per quarter during the first year of the term,
$500,000 per quarter during the second year of the term and $750,000 per
quarter during the third year of the term. Thereafter, there is no minimum
license fee. The sublicense expires on December 31, 2004, and will be
automatically renewed for subsequent five-year terms unless terminated by
either party. License fees earned under this agreement for the year ended
December 31, 1999, were $261,000, and for the nine months ended September 30,
2000, were $776,000.
Transactions with Other Affiliates
Administrative Services Arrangement. Effective October 1, 1999, we entered
into an Administrative Services Agreement with Orca Monitoring Services, a
wholly owned subsidiary of X10 Ltd., under which Orca provides to us
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telephone reception services, customer service and technical support after our
normal business hours, as well as general office administration and support.
The agreement expires October 1, 2000, and will be automatically renewed for
subsequent one-year terms unless terminated by mutual agreement of the parties.
We pay a service fee based upon head count, actual usage and an allocation of
floor space under Orca's lease. Administrative services fees paid or payable by
us to Orca from inception through December 31, 1997, were $91,000, for the
fiscal year ended December 31, 1998, were $327,000, for the fiscal year ended
December 31, 1999, were $990,000, and for the nine months ended September 30,
2000, were $723,000.
Conflicts of Interest Policy
Upon completion of this offering, our amended and restated bylaws will
provide that, prior to entering into any agreements or transactions with X10
Ltd. or any of its affiliates or subsidiaries that are required to be described
under Item 404 of Regulation S-K under the Securities Act, approval of a
majority of the directors serving on our audit committee must be obtained. In
addition, our agreements with X10 Ltd. and X-10 (USA) provide that, upon
completion of this offering, the approval of a majority of the directors
serving on our audit committee must be obtained to amend the agreements. Our
conflict of interest policy may not address all conflicts that may arise, and,
in any event, it is possible that conflicts may be resolved in a manner adverse
to us. For a description of risks related conflicts of interest, see "Risk
Factors--Some of the key management personnel on whom we depend are also
management personnel or employees of X10 Ltd. or its affiliates, which could
create conflicts of interest between X10 Ltd. or its affiliates and us."
Limitation of Liability and Indemnification Matters
Our amended and restated certificate of incorporation limits the liability
of directors to the maximum extent permitted by Delaware law. Delaware law
provides that directors of a corporation will not be personally liable for
monetary damages for breach of their fiduciary duties as directors, except
liability for:
. any breach of their duty of loyalty to the corporation or its
stockholders;
. acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
. unlawful payments of dividends or unlawful stock repurchases or
redemptions; or
. any transaction from which the director derived an improper personal
benefit.
This limitation of liability does not apply to liabilities arising under the
federal securities laws and does not affect the availability of equitable
remedies, such as injunctive relief or rescission.
Our amended and restated bylaws provide that we shall indemnify our
directors and executive officers and may indemnify our other officers and
employees and other agents to the fullest extent permitted by law. We believe
that indemnification under our amended and restated bylaws covers at least
negligence and gross negligence on the part of indemnified parties. Our amended
and restated bylaws also permit us to secure insurance on behalf of any
officer, director, employee or other agent for any liability arising out of his
or her actions in that capacity, regardless of whether our amended and restated
bylaws would permit indemnification.
Upon completion of this offering, we intend to enter into agreements to
indemnify our directors and certain officers, in addition to indemnification
provided for in our amended and restated bylaws. These agreements, among other
things, will indemnify our directors and certain officers for certain expenses,
including attorneys' fees, judgments, fines and settlement amounts incurred by
any of these persons in any action or proceeding, including any action by us
arising out of that person's services as our director or officer or that
person's services provided to any other company or enterprise at our request.
We believe that these provisions and agreements are necessary to attract and
retain qualified persons as directors and officers. We also intend to maintain
liability insurance for our officers and directors.
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PRINCIPAL STOCKHOLDERS
The following table provides information regarding the beneficial ownership
of our outstanding common stock as of October 31, 2000, and as adjusted to
reflect the sale of common stock offered hereby, as to:
. each person or group known to us to be the beneficial owner of more than
5% of our common stock;
. each of our directors;
. each named executive officer; and
. all of our directors and executive officers as a group.
Beneficial ownership is determined in accordance with the rules of the SEC
and generally includes voting or investment power with respect to securities.
In computing the number of shares beneficially owned by a person and the
percentage ownership of that person, shares of common stock subject to options
held by that person that are exercisable within 60 days of the date of this
table are deemed outstanding. These shares, however, are not deemed outstanding
for the purpose of computing the percentage ownership of any other person. All
percentages in this table are based on a total of 20,050,000 shares of common
stock outstanding on October 31, 2000, and 25,050,000 shares of common stock
outstanding after completion of this offering, adjusted in accordance with the
rules promulgated by the SEC. Except as indicated by the footnotes below, we
believe, based on information furnished to us and subject to community property
laws where applicable, that the persons and entities named in the table below
have sole voting and investment power with respect to all shares of common
stock shown as beneficially owned by them. Unless otherwise indicated, the
address for each of the named stockholders is c/o X10 Wireless Technology,
Inc., 15200 52nd Avenue South, Seattle, Washington 98188-2335.
<TABLE>
<CAPTION>
Percentage of
Shares
Beneficially
Number of Owned
Shares -----------------
Beneficially Before After
Name Owned Offering Offering
---- ------------ -------- --------
<S> <C> <C> <C>
George E. Stevenson(1)(2)................... 13,150,000 65.1% 52.2%
Alexander E. Peder(2)....................... 350,000 1.7 1.4
Wade A. Pfeiffer(2)......................... 137,500 * *
James R.W. Phillips(2)...................... 350,000 1.7 1.4
C. Gregory Amadon........................... -- * *
Bernard S. Appel............................ -- * *
William T. Baxter........................... -- * *
Hin Chew Chung(1)........................... 13,000,000 64.8 51.9
X10 Ltd..................................... 10,000,000 49.9 39.9
Room 1103-4 Hilder Center
2 Sung Ping Street
Hunghom, Kowloon, Hong Kong
All directors and executive officers as a
group (eight persons)(3)................... 16,987,500 83.3 66.9
</TABLE>
----------
* Less than one percent.
(1) Includes 10,000,000 shares held of record by X10 Ltd. with respect to
which Mr. Stevenson, as president and a director of X10 Ltd., and Mr.
Chung, as chairman of X10 Ltd., have or share voting and investment power.
(2) Includes shares of common stock subject to outstanding options exercisable
within 60 days of the date of this table as follows: 150,000 shares for
Mr. Stevenson, 50,000 shares for Mr. Peder, 87,500 shares for Mr.
Pfeiffer, 50,000 shares for Mr. Phillips and 337,500 shares for all
directors and executive officers as a group.
(3) Includes the information reflected in the notes above, as applicable.
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DESCRIPTION OF CAPITAL STOCK
Upon completion of this offering, our authorized capital stock will consist
of 100,000,000 shares of common stock, $0.001 par value, and 30,000,000 shares
of preferred stock, $0.001 par value. Prior to completion of this offering, we
will file with the Delaware Secretary of State an amended and restated
certificate of incorporation, which will become effective upon filing. For more
information, we refer you to the complete text of our amended and restated
certificate of incorporation and amended and restated bylaws, which are
included as exhibits to the registration statement of which this prospectus
forms a part, and to applicable provisions of Delaware law.
Common Stock
As of October 31, 2000, there were 20,050,000 shares of common stock
outstanding that were held of record by 35 stockholders. After giving effect to
the sale of common stock in this offering, there will be 25,050,000 shares of
common stock outstanding.
The holders of common stock are entitled to one vote per share on all
matters to be submitted to a vote of the stockholders. Subject to preferences
that may be applicable to any outstanding preferred stock, the holders of
common stock are entitled to receive ratably those dividends, if any, that may
be declared from time to time by our board of directors out of funds legally
available for dividends. In the event of the liquidation, dissolution or
winding up of our company, the holders of our common stock are entitled to
share ratably in all assets remaining after payment of liabilities, subject to
prior distribution rights of preferred stock, if any, then outstanding. Holders
of the common stock do not have cumulative voting, preemptive, conversion or
other subscription rights. No redemption or sinking fund provisions apply to
the common stock.
Preferred Stock
Pursuant to our amended and restated certificate of incorporation, our board
of directors has the authority, without further action by the stockholders, to
issue preferred stock in one or more series. With respect to each series, the
board has the authority to fix the number of shares, designations, powers,
preferences, privileges, and relative participating, optional or special rights
and the qualifications, limitations or restrictions of the series, including
dividend rights, conversion rights, voting rights, terms of redemption and
liquidation preferences, any or all of which may be greater than the rights of
the common stock. Our board of directors, without stockholder approval, can
issue preferred stock with voting, conversion or other rights that could
adversely affect the voting power and other rights of the holders of common
stock. Preferred stock could thus be issued quickly with terms calculated to
delay, deter or prevent a change in our control or make removal of management
more difficult. Additionally, the issuance of preferred stock may have the
effect of decreasing the market price of our common stock and may adversely
affect the voting and other rights of the holders of common stock. There are no
shares of preferred stock outstanding, and we have no plans to issue any
preferred stock.
Antitakeover Effects of Our Charter Documents, Delaware and Washington Law
Provisions of our amended and restated certificate of incorporation and
amended and restated bylaws may have the effect of delaying, deterring or
preventing a tender offer or other change in control that the stockholders
might consider to be in their best interests, including those changes in
control that might result in a premium over the market price for the shares
held by our stockholders.
Advance Notice Requirements for Stockholder Proposals and Director
Nominations. Our amended and restated bylaws provide that stockholders seeking
to present proposals before a meeting of stockholders or to nominate candidates
for election as directors at a meeting of stockholders must provide timely
notice in writing. Our amended and restated bylaws also specify requirements as
to the form and content of a stockholder's notice. These provisions may delay
or preclude stockholders from bringing matters before a meeting of stockholders
or from making nominations for directors at a meeting of stockholders, which
could delay or deter takeover attempts or changes in management.
65
<PAGE>
Classified Board of Directors. Following this offering, our board of
directors will be divided into three classes. The classification of the board
of directors will have the effect of requiring at least two annual stockholder
meetings, instead of one, to replace a majority of the directors, which could
have the effect of delaying or preventing a change in control or management of
our company.
Director Removal and Vacancies. Subject to the rights of the holders of any
outstanding series of preferred stock, our amended and restated certificate of
incorporation provides that all vacancies, including newly created
directorships, may, except as otherwise required by law, be filled only by the
affirmative vote of a majority of directors then in office, even though less
than a quorum. In addition, our amended and restated certificate of
incorporation provides that the board of directors may fix the number of
directors by resolution. The amended and restated certificate also provides
that, following this offering, directors may not be removed without cause.
Stockholder Action By Written Consent; Special Meetings of Stockholders. Our
amended and restated certificate of incorporation provides that, following this
offering, all stockholder action must be effected at a duly called meeting of
stockholders and not by written consent. Further, our amended and restated
bylaws provide that special meetings of stockholders may be called only by the
chairman of the board, chief executive officer or by a majority of the board of
directors. These provisions may lengthen the time required to take stockholder
action and, as a result, may delay, deter or prevent changes in our control or
management.
No Cumulative Voting. Our amended and restated certificate of incorporation
does not include a provision for cumulative voting for directors. The absence
of cumulative voting may make it difficult for a minority stockholder to elect
any directors to our board.
Business Combination Statutes. We are subject to the provisions of Section
203 of the Delaware General Corporation Law. Subject to specified exceptions,
Section 203 prohibits a publicly held Delaware corporation from engaging in a
"business combination" with an "interested stockholder" for a period of three
years from the date of the transaction in which the person became an interested
stockholder, unless the interested stockholder attained this status with the
approval of the board of directors or unless the business combination is
approved in a prescribed manner. A "business combination" includes a merger,
asset sale or other transaction resulting in a financial benefit to the
interested stockholder. Subject to specified exceptions, an "interested
stockholder" is a person who, together with affiliates and associates, owns, or
within three years did own, 15% or more of the corporation's voting stock. This
statute could have the effect of preventing or delaying the completion of
mergers, takeovers or other changes in control and, accordingly, may discourage
attempts to acquire us.
In addition, the laws of the state of Washington, where our principal
executive offices are located, impose restrictions on transactions between
foreign corporations and significant stockholders. Chapter 23B.19 of the
Washington Business Corporation Act generally prohibits a target corporation
from engaging in significant business transactions with a person or group of
persons that beneficially owns 10% or more of the voting securities of the
target corporation, referred to as an "acquiring person," for a period of five
years after the acquiring person's acquisition of securities, unless a majority
of the members of the target corporation's board of directors approves the
transaction or acquisition of shares before its completion. Prohibited
transactions include:
. a merger, share exchange or consolidation with, disposition of assets
to, or issuance or redemption of stock to or from, the acquiring person;
. termination of 5% or more of the employees of the target corporation as
a result of the acquiring person's acquisition of 10% or more of the
shares; and
. allowing the acquiring person to receive any disproportionate benefit as
a stockholder.
After the five-year period, a significant business transaction may take place
so long as it complies with the fair price provisions of the statute or is
approved at an annual or special meeting of stockholders. A target
66
<PAGE>
corporation includes a foreign corporation if the corporation's principal
executive office is located in Washington.
A corporation may not opt out of this statute. If we continue to meet the
definition of a target corporation, Chapter 23B.19 of the Washington Business
Corporation Act may have the effect of delaying, deterring or preventing a
change of control of our company.
Upon completion of this offering, X10 Ltd. and its controlling stockholders
will beneficially own approximately 64.1% of the outstanding shares of our
common stock, including 52.2% beneficially owned by George Stevenson, our chief
executive officer and chairman of the board and 51.9% beneficially owned by
Hin Chew Chung, one of our directors. As a result, X10 Ltd. and its controlling
stockholders will have the ability to control most matters requiring the vote
of our stockholders, including the election of our directors and our corporate
actions. This concentration of ownership and other rights could result in
conflicts of interest between these stockholders and us, impede our business
development through loss of corporate opportunities or otherwise, or delay or
deter others from initiating a potential merger, takeover or other change in
control, even if these events would benefit our stockholders and us. This
concentration of ownership may also depress the market price of our common
stock. For a discussion of risks related to concentration of ownership, see
"Risk Factors--The rights of our stockholders could be adversely affected
because we are controlled by X10 Ltd. and its stockholders."
Transfer Agent and Registrar
The transfer agent and registrar for our common stock is Computershare Trust
Company, Inc., Lakewood, Colorado.
Nasdaq National Market Listing
Our common stock has been approved for quotation on the Nasdaq National
Market of The Nasdaq Stock Market, Inc. under the trading symbol "XTEN."
67
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for our common
stock. No predictions can be made as to the effect, if any, that market sales
of shares of our common stock from time to time, or the availability of shares
for future sale, may have on the market price for our common stock. Sales of
substantial amounts of common stock, or the perception that such sales could
occur, could adversely affect prevailing market prices for our common stock and
could impair our future ability to obtain capital through an offering of equity
securities.
Based on shares outstanding at October 31, 2000, upon completion of this
offering, we will have 25,050,000 shares of common stock outstanding, assuming
no exercise of the underwriters' over-allotment option and no exercise of
outstanding options. Of these outstanding shares, the 5,000,000 shares sold in
this offering will be freely tradable without restrictions or further
registration under the Securities Act, unless the shares are purchased by our
affiliates as that term is defined in Rule 144 under the Securities Act.
The remaining 20,050,000 shares of common stock outstanding after the
offering are restricted securities as defined in Rule 144. Restricted
securities may be sold in the U.S. public market only if registered or if they
qualify for an exemption from registration under Rule 144, 144(k) or 701
promulgated under the Securities Act, which are summarized below.
<TABLE>
<CAPTION>
Eligibility of Restricted
Shares for Sale
Days After the Effective Date in U.S. Public Market Comment
----------------------------- ------------------------- ----------------------------
<S> <C> <C>
On effectiveness........ 5,000,000 Shares sold in the offering
180 days................ 3,700,600 Shares saleable under Rule
144 that are not subject to
the lock up
At various times after 20,050,000 Lock up released: shares
180 days............... saleable under Rules 144 and
701
</TABLE>
Additionally, of the 1,450,000 shares issuable upon exercise of options to
purchase our common stock outstanding as of October 31, 2000, approximately
362,500 shares will be vested and eligible for sale 180 days after the date of
this prospectus.
Rule 144. In general, under Rule 144 as currently in effect, beginning 90
days after the date of this prospectus, a person who has beneficially owned
restricted securities for at least one year, including the holding period of
any prior owner other than an affiliate of ours, is entitled to sell a number
of shares within any three-month period that does not exceed the greater of one
percent of the number of shares of our common stock then outstanding, which
will equal approximately 250,500 shares immediately after the offering, and the
average weekly trading volume of our common stock on the Nasdaq National Market
during the four calendar weeks preceding the filing of a notice on Form 144
with respect to the sale. Sales under Rule 144 are also subject to manner-of-
sale provisions, notice requirements and the availability of current public
information about us. Rule 144 also provides that affiliates that sell shares
of common stock that are not restricted shares must nonetheless comply with the
same restrictions applicable to restricted shares, with the exception of the
holding period requirement.
Rule 144(k). Under Rule 144(k), a person who is not deemed to have been our
affiliate at any time during the 90 days preceding a sale and who has
beneficially owned the shares proposed to be sold for at least two years,
including the holding period of any prior owner other than an affiliate, may
sell those shares without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144.
Rule 701. Rule 701 provides that the shares of common stock acquired upon
the exercise of currently outstanding options or pursuant to other rights
granted under our stock plans may be resold, to the extent not
68
<PAGE>
subject to lock-up agreements, by persons other than affiliates, beginning 90
days after the date of this prospectus, subject only to the manner-of-sale
provisions of Rule 144, and by affiliates under Rule 144, without compliance
with its one-year minimum holding period, subject to the manner of sale,
current public information and filing limitations and requirements of Rule 144.
As of October 31, 2000, options to purchase a total of 1,450,000 shares of
common stock were outstanding, of which options to purchase 362,500 shares are
exercisable. Of the total shares issuable pursuant to these options, all are
subject to contractual lock-up agreements with the representatives of the
underwriters.
We intend to file one or more registration statements on Form S-8 under the
Securities Act following the offering to register the shares of common stock
that are issuable pursuant to our 1999 plan, incentive plan and purchase plan.
These registration statements are expected to become effective upon filing.
Shares covered by these registration statements will then be eligible for sale
in the public markets, subject to any applicable lock-up agreements and to Rule
144 limitations applicable to affiliates.
Regulation S. In general, Regulation S promulgated under the Securities Act
allows for the resale of otherwise restricted securities outside the U.S.
without registration. As of October 31, 2000, 3,000,000 shares of our common
stock may be sold outside the U.S. by stockholders who are not our affiliates
in an "offshore transaction," provided that neither the seller nor any person
acting on the seller's behalf, engages in "directed selling efforts" in the
U.S. Under Regulation S, "directed selling efforts" means any activity
undertaken for the purpose of, or that could reasonably be expected to have the
effect of, conditioning the market in the U.S. for any of the securities being
offered. A number of additional restrictions apply to our stockholders who are
our affiliates, other than by virtue of their status as one of our directors or
officers.
Lock-up Agreements
Our executive officers, directors and all of our stockholders have agreed
not to, among other things, sell or otherwise dispose or transfer the economic
benefit of, directly or indirectly, any shares of common stock, or any security
convertible into or exchangeable or exercisable for common stock, without the
prior written consent of Bear, Stearns & Co. Inc. for a period of 180 days from
the date of this prospectus. However, the lock-up agreement permits gifts to
immediate family members or trusts and other transfers for estate planning
purposes as well as transfers of shares of our common stock purchased on the
open market. Bear, Stearns & Co. Inc. may, in its sole discretion, at any time
and without notice, release for sale in the public market all or any portion of
the shares subject to the lock-up agreements.
69
<PAGE>
UNDERWRITING
Subject to the terms and conditions of an underwriting agreement dated
, 2000, between us and the underwriters named below, who are represented
by Bear, Stearns & Co. Inc., Prudential Securities Incorporated, and C.E.
Unterberg, Towbin, each of the underwriters named below has severally agreed to
purchase from us the following respective number of shares of common stock set
forth opposite its name below at the public offering price less the
underwriting discounts and commissions set forth on the cover page of this
prospectus.
<TABLE>
<CAPTION>
Number
of
Underwriter Shares
----------- ------
<S> <C>
Bear, Stearns & Co. Inc. .............................................
Prudential Securities Incorporated....................................
C.E. Unterberg, Towbin................................................
----
Total...............................................................
====
</TABLE>
The underwriting agreement provides that the underwriters are obligated to
purchase all of the shares of common stock, other than shares of common stock
covered by the over-allotment option described below, if they purchase any of
the shares. Those obligations are subject, however, to various conditions,
including the approval of legal matters by their counsel.
We have agreed to indemnify the underwriters against various liabilities,
including liabilities under the Securities Act, and, where such indemnification
is unavailable, to contribute to payments that the underwriters may be required
to make in respect of such liabilities.
The underwriters propose initially to offer the shares of common stock
directly to the public at the public offering price set forth on the cover page
of this prospectus and to selected dealers at such price less a concession not
to exceed $ per share. The underwriters may allow, and such selected
dealers may re-allow a concession not to exceed $ per share on sales to
other dealers and that after the initial offering of the shares to the public,
the public offering price, concessions and other selling terms may be changed.
The underwriters do not intend to confirm sales to any accounts over which they
exercise discretionary authority.
We have granted to the underwriters an option to purchase in the aggregate
up to 750,000 additional shares to be sold in this offering at the public
offering price less the underwriting discount set forth on the cover page of
this prospectus. The underwriters may exercise this option solely to cover
overallotments, if any, made in connection with this offering. The option may
be exercised in whole or in part at any time within 30 days after the date of
this prospectus. To the extent the option is exercised, the underwriters will
be severally committed, subject to several conditions, including the approval
of legal matters by their counsel, to purchase the additional shares of common
stock in proportion to their respective purchase commitments as indicated in
the preceding table.
The underwriting fee is equal to the public offering price per share of
common stock less the amount paid by the underwriters to us per share of common
stock. The following table shows the underwriting discounts and commissions to
be paid to the underwriters by us. Such amounts are shown assuming both no
exercise and full exercise of the underwriters' option to purchase additional
shares.
<TABLE>
<CAPTION>
Per Share Total
------------------- -------------------
Without With Without With
Over- Over- Over- Over-
Allotment Allotment Allotment Allotment
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Underwriting discounts and commissions
payable by us........................ $ $ $ $
</TABLE>
We estimate that the total expenses of the offering, excluding underwriting
discounts and commissions, will be approximately $ . The offering of the
shares is made for delivery, when, as and if accepted by
70
<PAGE>
the underwriters and subject to prior sale and to withdrawal, cancellation or
modification of the offering without notice. The underwriters reserve the right
to reject an order for the purchase of shares in whole or in part.
At our request, the underwriters have reserved for sale at the initial
public offering price up to 5% of the number of shares of common stock to be
sold in this offering to persons associated with us, such as associates of some
of our employees and selected employees of companies with which we are
developing or have commercial relationships. The number of shares available for
sale to the general public will be reduced to the extent any reserved shares
are purchased. Any reserved shares not so purchased will be offered by the
underwriters on the same basis as the other shares offered hereby and will not
be subject to resale restrictions.
Our executive officers, directors and all of our stockholders have agreed
not to, among other things, sell or otherwise dispose or transfer the economic
benefit of, directly or indirectly, any shares of common stock, or any security
convertible into or exchangeable or exercisable for common stock, without the
prior written consent of Bear, Stearns & Co. Inc. for a period of 180 days from
the date of this prospectus. However, the lock-up agreement permits gifts to
immediate family members or trusts and other transfers for estate planning
purposes as well as transfers of shares of our common stock purchased on the
open market. Bear, Stearns & Co. Inc. may, in its sole discretion, at any time
and without notice, release for sale in the public market all or any portion of
the shares subject to the lock-up agreements.
Prior to this offering, there has been no public market for our common
stock. Consequently, the initial public offering price will be determined
through negotiations among us and the representatives of the underwriters. The
primary factors considered in determining the public offering price will be:
. our financial and operating history and condition;
. market valuations of other companies engaged in activities similar to
ours;
. our prospects and prospects for the industry in which we do business in
general;
. our management;
. prevailing equity market conditions; and
. the demand for securities considered comparable to ours.
In connection with the offering, the underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in the offering. Covered
short sales are sales made in an amount not greater than the underwriters'
option to purchase additional shares from us in the offering. The underwriters
may close out any covered short position by either exercising their option to
purchase additional shares or purchasing shares in the open market. Naked short
sales are any sales in excess of the underwriters' option to purchase
additional shares from us. The underwriters must close out any naked short
position by purchasing shares on the open market. Stabilizing transactions
consist of various bids for or purchases of common stock made by the
underwriters in the open market prior to the completion of the offering.
The underwriters also may impose a penalty bid. This occurs when a
particular underwriter repays to the underwriters a portion of the underwriting
discount received by it because the representatives have repurchased shares
sold by or for the account of such underwriter in stabilizing or short covering
transactions.
Purchases to cover a short position and stabilizing transactions may have
the effect of preventing or retarding a decline in the market price of our
stock and, together with the imposition of the penalty bid, may stabilize,
maintain or otherwise affect the market price of the common stock. As a result,
the price of the common stock may be higher than the price that otherwise might
exist in the open market. If these activities are commenced, they may be
discontinued at any time. These transactions may be effected on the Nasdaq
National Market, in the over-the-counter market or otherwise.
71
<PAGE>
Prudential Securities Incorporated facilitates the marketing of new issues
online through its PrudentialSecurities.com division. Clients of Prudential
Advisor SM, a full service brokerage firm program, may view offering terms and
a prospectus online and place orders through their financial advisors.
LEGAL MATTERS
The validity of the issuance of the common stock offered hereby will be
passed upon for us by Cooley Godward llp, Kirkland, Washington. Certain legal
matters in connection with this offering will be passed upon for the
underwriters by Gray Cary Ware & Freidenrich llp, Seattle, Washington.
EXPERTS
The financial statements as of December 31, 1998 and 1999, for the period
from July 1, 1997 (inception) to December 31, 1997, and for the years ended
December 31, 1998 and 1999, included in this prospectus have been audited by
Deloitte & Touche LLP, independent auditors, as stated in their report
appearing herein (which report expresses an unqualified opinion and includes
explanatory paragraphs relating to the restatement of the 1999 financial
statements and the preparation of the financial statements from the books and
records of X10 Ltd. and X-10 (USA) Inc.), and have been so included in reliance
upon the report of such firm given upon their authority as experts in
accounting and auditing.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed with the SEC a registration statement on Form S-1 under the
Securities Act that registers the shares of our common stock to be sold in this
offering. The registration statement, including the attached exhibits and
schedules, contains additional relevant information about us and our capital
stock. For further information about us and our common stock, reference is made
to the registration statement and the exhibits and schedules filed with the
registration statement. With respect to statements contained in this prospectus
regarding the contents of any agreement or any other document, in each
instance, reference is made to the complete text of the agreement or document,
a copy of which has been filed as an exhibit to the registration statement. The
rules and regulations of the SEC allow us to omit certain information included
in the registration statement from this document.
For further information with respect to us and our common stock, reference
is made to the registration statement and the exhibits and schedules filed with
the registration statement.
In addition, upon completion of this offering, we will file reports, proxy
statements and other information with the SEC under the Securities Exchange Act
of 1934. You may read and copy this information at the following public
reference rooms of the SEC:
<TABLE>
<S> <C> <C>
Washington, D.C. New York, New York Chicago, Illinois
450 Fifth Street, N.W. 7 World Trade Center 500 West Madison Street
Room 1024 Suite 1300 Suite 1400
Washington, D.C. 20549 New York, NY 10048 Chicago, IL 60661
</TABLE>
You may also obtain copies of this information by mail from the Public
Reference Section of the SEC, 450 Fifth Street, N.W., Room 1024, Washington,
D.C. 20549, at prescribed rates. You may obtain information on the operation of
the public reference rooms by calling the SEC at 1-800-SEC-0330. The SEC also
maintains an Internet website that contains reports, proxy statements and other
information about issuers, like us, who file electronically with the SEC. The
address of that site is http://www.sec.gov.
72
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Report............................................... F-2
Statements of Operations................................................... F-3
Balance Sheets............................................................. F-4
Statements of Changes in Stockholders' Equity (Owner's Net Deficit)........ F-5
Statements of Cash Flows................................................... F-6
Notes to Financial Statements.............................................. F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
X10 Wireless Technology, Inc.
Seattle, Washington
We have audited the accompanying balance sheets of X10 Wireless Technology,
Inc. (the "Company") as of December 31, 1998 and 1999 and the related
statements of operations, changes in stockholders' equity (owner's net
deficit), and cash flows for the period from July 1, 1997 (inception) to
December 31, 1997 and for the years ended December 31, 1998 and 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of X10 Wireless Technology, Inc. at December
31, 1998 and 1999, and the results of its operations and its cash flows for the
period from July 1, 1997 (inception) to December 31, 1997 and for the years
ended December 31, 1998 and 1999 in conformity with accounting principles
generally accepted in the United States of America.
As discussed in note 8, the accompanying 1999 financial statements have been
restated.
The accompanying financial statements have been prepared from the records
maintained by X10 Ltd. and X-10 (USA) Inc. and may not necessarily be
indicative of the conditions that would have existed or the results of
operations if X10 Wireless Technology, Inc. had been operated as an
unaffiliated entity. Portions of certain expenses represent allocations made
from and applicable to X10 Ltd. and X-10 (USA) Inc. as a whole.
/s/ Deloitte & Touche LLP
Seattle, Washington
July 28, 2000 (November 17, 2000, as to notes 7 and 8)
F-2
<PAGE>
X10 WIRELESS TECHNOLOGY, INC.
STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
For the
Period
July 1, 1997 Nine Months
(inception) Year Ended Ended
to December 31, September 30,
December 31, ---------------------- ----------------
1997 1998 1999 1999 2000
------------ ------- ------------- ------- -------
(As restated, (unaudited)
see note 8)
<S> <C> <C> <C> <C> <C>
Net revenues............. $ 134 $ 2,997 $15,893 $ 9,941 $21,322
Cost of revenues......... 56 1,143 8,980 5,187 12,907
----- ------- ------- ------- -------
Gross profit............. 78 1,854 6,913 4,754 8,415
----- ------- ------- ------- -------
Operating expenses:
Research and
development, excluding
$0, $0, $65, $0 and
$206, respectively, of
non-cash stock-based
compensation.......... 1 71 712 571 1,110
Sales and marketing,
excluding $0, $0, $65,
$0 and $206,
respectively, of non-
cash stock-based
compensation.......... 43 2,583 8,844 5,684 10,769
General and
administrative,
excluding $0, $0,
$1,699, $0 and $1,082,
respectively, of non-
cash stock-based
compensation.......... 305 1,031 2,879 1,955 3,202
Non-cash stock-based
compensation.......... -- -- 1,829 -- 1,494
----- ------- ------- ------- -------
Total operating
expenses............ 349 3,685 14,264 8,210 16,575
----- ------- ------- ------- -------
Loss from operations..... (271) (1,831) (7,351) (3,456) (8,160)
Interest income.......... -- -- 2 -- 48
----- ------- ------- ------- -------
Net loss............. $(271) $(1,831) $(7,349) $(3,456) $(8,112)
===== ======= ======= ======= =======
Basic and diluted net
loss per common share... $ (0.40)
=======
Weighted average shares
used to compute basic
and diluted net loss per
common share............ 20,050
=======
Pro forma basic and
diluted net loss per
common share
(unaudited)............. $ (0.37)
=======
Weighted average shares
used to compute pro
forma basic and diluted
net loss per common
share (unaudited)....... 20,050
=======
</TABLE>
See Notes to Financial Statements.
F-3
<PAGE>
X10 WIRELESS TECHNOLOGY, INC.
BALANCE SHEETS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
December 31,
---------------------- September 30,
1998 1999 2000
------- ------------- -------------
(As restated, (unaudited)
see note 8)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............... $ -- $ 1,878 $ 2,323
Accounts receivable..................... -- -- 1,148
Inventory............................... 112 109 98
Prepaid expenses and other current
assets ................................ -- 24 10
Due from related parties................ 715 -- --
------- ------- -------
Total current assets.................. 827 2,011 3,579
Property and equipment, net............... -- 59 103
Deferred offering costs................... -- -- 1,544
------- ------- -------
Total assets.......................... $ 827 $ 2,070 $ 5,226
======= ======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
(OWNER'S NET DEFICIT)
Current liabilities:
Accounts payable and accrued expenses... $ 13 $ 177 $ 1,231
Accrued advertising expense............. 1,060 1,865 4,315
Deferred revenue........................ 334 144 67
Sales tax payable....................... 69 312 393
Allowance for returns................... 83 297 156
Accrued payroll and other employee
benefits............................... 27 54 115
Due to related parties.................. -- 1,174 6,798
------- ------- -------
Total current liabilities............. 1,586 4,023 13,075
------- ------- -------
Commitments and contingencies (Note 5)
Stockholders' equity (owner's net
deficit):
Net contribution from X10 Ltd. ......... 1,343 -- --
Accumulated deficit..................... (2,102)
Preferred stock, par value $0.001 per
share; 30,000 shares authorized, none
outstanding............................ -- -- --
Common stock, par value $0.001 per
share; 100,000 shares authorized;
20,050 shares issued and outstanding
(December 31, 1999 and September 30,
2000).................................. -- 20 20
Unearned compensation................... -- (3,139) (2,653)
Additional paid-in capital.............. -- 5,059 6,789
Retained earnings (deficit)............. -- (3,893) (12,005)
------- ------- -------
Total stockholders' equity (owner's
net deficit)......................... (759) (1,953) (7,849)
------- ------- -------
Total liabilities and stockholders'
equity (owner's net deficit)......... $ 827 $ 2,070 $ 5,226
======= ======= =======
</TABLE>
See Notes to Financial Statements.
F-4
<PAGE>
X10 WIRELESS TECHNOLOGY, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (OWNER'S NET DEFICIT)
(in thousands)
<TABLE>
<CAPTION>
Net
Contribution Additional Retained
From Accumulated Common Unearned Paid-in Earnings
Total X10 Ltd. Deficit Stock Compensation Capital (Deficit)
------- ------------ ----------- ------ ------------ ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, July 1, 1997.................... $ -- $ -- $ -- $ -- $ -- $ -- $ --
Net loss................................ (271) -- (271) -- -- -- --
Capital contributions from X10 Ltd...... 345 345 -- -- -- -- --
------- ------- ------- ---- ------- ------ --------
Balance, December 31, 1997............... 74 345 (271) -- -- -- --
Net loss................................ (1,831) -- (1,831) -- -- -- --
Capital contributions from X10 Ltd...... 998 998 -- -- -- -- --
------- ------- ------- ---- ------- ------ --------
Balance, December 31, 1998............... (759) 1,343 (2,102) -- -- -- --
Net loss for the nine months ended
September 30, 1999..................... (3,456) -- (3,456) -- -- -- --
Capital contributions from X10 Ltd...... 3,073 3,073 -- -- -- -- --
------- ------- ------- ---- ------- ------ --------
Balance, September 30, 1999.............. (1,142) 4,416 (5,558) -- -- -- --
Conversion of X10 Ltd.'s net investment
and additional contributed net
liabilities to common stock............ 1,243 (4,416) 5,558 10 -- 91 --
Issuance of common stock, at par........ 10 -- -- 10 -- -- --
Unearned compensation relating to
issuance of stock options (as restated,
see note 8)............................ -- -- -- -- (3,609) 3,609 --
Unearned compensation relating to sale
of shares by shareholder to individuals
at less than fair value (as restated,
see note 8)............................ -- -- -- -- (1,359) 1,359 --
Amortization of unearned compensation
(as restated, see note 8).............. 1,829 -- -- -- 1,829 -- --
Net loss for the three months ended
December 31, 1999 (as restated, see
note 8)................................ (3,893) -- -- -- -- -- (3,893)
------- ------- ------- ---- ------- ------ --------
Balance, December 31, 1999 (as restated,
see note 8)............................. (1,953) -- -- 20 (3,139) 5,059 (3,893)
Unearned compensation relating to
issuance of stock options (unaudited).. -- -- -- -- (1,008) 1,008 --
Amortization of unearned compensation
(unaudited)............................ 1,494 -- -- -- 1,494 -- --
Capital contribution from X10 Ltd.
(unaudited)............................ 722 -- -- -- -- 722 --
Net loss (unaudited).................... (8,112) -- -- -- -- -- (8,112)
------- ------- ------- ---- ------- ------ --------
Balance, September 30, 2000 (unaudited).. $(7,849) $ -- $ -- $ 20 $(2,653) $6,789 $(12,005)
======= ======= ======= ==== ======= ====== ========
</TABLE>
See Notes to Financial Statements.
F-5
<PAGE>
X10 WIRELESS TECHNOLOGY, INC.
STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
For the Period Nine Months
July 1, 1997 Year Ended Ended
(inception) to December 31, September 30,
December 31, --------------------- ----------------
1997 1998 1999 1999 2000
-------------- ------- ------------ ------- -------
(As restated (unaudited)
see note 8)
<S> <C> <C> <C> <C> <C>
Operating activities:
Net loss.............. $(271) $(1,831) $(7,349) $(3,456) $(8,112)
Adjustments to
reconcile net loss to
net cash provided by
(used in) operating
activities:
Depreciation......... -- -- 5 -- 25
Amortization of
unearned
compensation........ -- -- 1,829 -- 1,494
Changes in operating
accounts:
Accounts
receivable......... -- -- -- -- (1,148)
Inventory........... (1) (111) 3 (12) 11
Amounts due to/from
related parties.... (99) (615) 3,073 (351) 5,624
Other assets........ -- -- (14) (13) 4
Accounts payable and
accrued expenses... 23 1,228 1,453 1,542 3,505
Deferred revenue.... 3 331 (191) (150) (77)
----- ------- ------- ------- -------
Total cash (used)
provided by
operating
activities........ (345) (998) (1,191) (2,440) 1,326
----- ------- ------- ------- -------
Investing activities:
Purchases of furniture
and equipment........ -- -- (4) -- (69)
----- ------- ------- ------- -------
Total cash used in
investing
activities........ -- -- (4) -- (69)
----- ------- ------- ------- -------
Financing activities:
Net cash contributions
from X10 Ltd. ....... 345 998 3,073 3,073 722
Initial public
offering costs....... -- -- -- -- (1,544)
Payment of note
receivable........... -- -- -- -- 10
----- ------- ------- ------- -------
Total cash (used)
provided by
financing
activities........ 345 998 3,073 3,073 (812)
----- ------- ------- ------- -------
Net increase in cash
and cash equivalents.. -- -- 1,878 633 445
Cash and cash
equivalents,
beginning............. -- -- -- 1,878
----- ------- ------- ------- -------
Cash and cash
equivalents, ending... $ -- $ -- $ 1,878 $ 633 $ 2,323
===== ======= ======= ======= =======
Supplemental disclosure
of non-cash investing
and financing
activities:
Issuance of common
stock to X10 Ltd. for
certain agreements and
technology............ $ 1,024
Note receivable for X-
10 (USA) liabilities
assumed............... $ 1,183
Issuance of common
stock to individuals
for notes which were
paid in May 2000...... $ 10
</TABLE>
See Notes to Financial Statements.
F-6
<PAGE>
X10 WIRELESS TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1. Description of Business and Summary of Significant Accounting Policies
Description of business: X10 Wireless Technology, Inc. (the "Company")
offers affordable products that allow consumers to network devices, systems and
appliances within homes and small offices. These products are based on a
variety of technologies including high-capacity content delivery technologies,
commonly referred to as broadband, as well as wireless, phoneline, electrical
and infrared technologies. The Company designs, develops and markets broadband
wireless products that enable users to receive and deliver video and audio
content and to distribute broadband Internet content from a PC to televisions,
stereos and other electronic entertainment devices within a home or small
office. In addition, the Company offers networking products based on other
technologies that enable consumers to control security, lighting, heating and
air conditioning systems. All of these products can operate together to create
a home or small office network. Users can access and control these products
directly from a personal computer, or PC, or through remote controls, wall-
mounted panels, telephones or the Internet. The Company sells these broadband
wireless and control products primarily over the Internet. In addition, the
Company has recently commenced sales of these products, indirectly through its
affiliates, to sellers of customized, bundled or private-label versions of
these products and to retailers, independent contractors and value-added
resellers.
In July 1997, the Company began operating as a division of X-10 (USA) Inc.
("X-10 (USA)"), a wholly owned subsidiary of X10 Ltd., a Hong Kong-based
company which, together with its affiliates, designs and manufactures home
controls, entertainment and security technology products. On October 1, 1999,
the Company began operating as a separate entity, with the objective of
building an independent U.S. company focused on the design, development and
sale of broadband wireless products. The Company has entered into several
agreements with X10 Ltd. and X-10 (USA) relating to the transfer of technology
and other intellectual property rights and net assets, the manufacture and
distribution by them and their affiliates of products incorporating the
technology and intellectual property rights, and the provision of research and
development services to the Company. See Note 2 for a summary of agreements.
Basis of presentation: The financial statements present the results of
operations, balance sheets, changes in stockholders' equity (owner's net
deficit), and cash flows applicable to the operations of the Company. The
financial statements from July 1, 1997 (inception) to September 30, 1999, are
derived from the historic books and records of X10 Ltd. and X-10 (USA). The
Company did not maintain corporate treasury, legal, tax and other similar
corporate support functions. For purposes of preparing the accompanying
financial statements, certain X10 Ltd. and X-10 (USA) corporate costs were
allocated to the Company using the allocation methods described in Note 3.
Estimates and assumptions: Preparing financial statements requires
management to make estimates and assumptions that affect the reported amounts
of assets, liabilities, revenues and expenses. Actual results could differ from
those estimates.
Cash and cash equivalents: The Company considers all highly liquid
instruments purchased with original maturities of 90 days or less to be cash
equivalents.
Accounts Receivable: Accounts receivable at September 30, 2000, consist of
amounts due from three customers. No amounts are considered uncollectible.
Inventory: Inventory is stated at the lower of cost or market. Inventory
consists of products ordered but not yet shipped to the customer, which
commonly consists of several days. The Company does not stock its own inventory
or maintain warehouse locations. Under terms of the Amended and Restated
Product Supply Agreement discussed in Note 2, the Company provides to X10 Ltd.
a product delivery request specifying product, quantity and delivery date to a
designated warehouse. The Company purchases product, and takes title,
F-7
<PAGE>
X10 WIRELESS TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
at the earlier of submission of a purchase order to X10 Ltd. or 120 days after
delivery of product by X10 Ltd. to the designated warehouse.
Property and equipment: Property and equipment consists primarily of
computer equipment, which is carried at historical cost, net of accumulated
depreciation. Depreciation expense is recorded using the straight-line method
over the estimated useful lives of the assets, ranging from two to three years.
Accumulated depreciation on these assets was $5,000 and $30,000 (unaudited) at
December 31, 1999 and September 30, 2000, respectively. No fixed assets were
owned prior to October 1999.
Deferred revenue: Deferred revenue represents product ordered and paid for
by the customer which has not yet been shipped.
Revenue recognition: Net revenues consist of product sales, net of
allowances for product returns and discounts, and license fees. Revenues from
product sales transactions are recognized upon shipment to the customer. The
Company establishes product pricing, obtains title to the product upon
placement of an order, retains credit and collection risk and is the merchant
of record on credit card transactions. Accordingly, the Company records as
revenue the amount billed to a customer, net of returns, and records as cost of
revenues amounts incurred under the Amended and Restated Product Supply
Agreement described in Note 2.
Vouchers entitling the customer to a reduction in sales price on future
purchases are recognized as a reduction in revenue when exercised by the
customer.
Some of the Company's products include software that is used solely in
connection with operation of the products. The software is not sold or marketed
separately. Once installed, the software is not updated for new versions that
may be developed subsequently. The Company does not provide maintenance or
postcontract customer support. As such, the provisions of American Institute of
Certified Public Accountants ("AICPA") Statement of Position ("SOP") 97-2,
Software Revenue Recognition, and SOP 98-9, Modification of SOP 97-2, With
Respect to Certain Transactions, have not had a significant impact on the
Company's revenue recognition.
Allowance for sales returns: The Company provides allowances for sales
returns in the period of sale based on historical experience. Following is a
schedule of the allowance for sales and return activity.
<TABLE>
<CAPTION>
Beginning Charged to Actual sales Ending
Description balance revenues returns balance
----------- --------- ---------- ------------ -------
(dollars in thousands)
<S> <C> <C> <C> <C>
Allowance for sales returns
1997.......................... $ -- $ 10 $ 6 $ 4
1998.......................... 4 207 128 83
1999.......................... 83 1,146 932 297
Nine months ended September
30, 1999 (unaudited)......... 83 647 599 131
Nine months ended September
30, 2000 (unaudited)......... 297 798 939 156
</TABLE>
Shipping and handling costs: Shipping and handling costs are included in the
statement of operations under the caption sales and marketing.
Research and development: Research and development expenses consist
primarily of payroll and other costs related to development of new technology
and products.
F-8
<PAGE>
X10 WIRELESS TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Advertising costs: The Company expenses advertising costs as incurred. There
was no advertising expense in the period from July 1, 1997 (inception) to
December 31, 1997. Advertising expense was $2.0 million and $5.8 million for
the years ended December 31, 1998 and 1999, respectively. Advertising expense
was $3.7 million (unaudited) and $7.0 million (unaudited) for the nine months
ended September 30, 1999 and 2000, respectively.
Certain risks and concentrations: The Company's business is subject to other
risks and uncertainties common to growing technology-based companies, including
rapid technological change, growth and commercial acceptance of the Internet,
dependence on third-party technology, new product introductions and other
activities of competitors, dependence on key personnel, international
expansion, and limited operating history.
Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist principally of its holdings of cash in a
single bank account.
Reliance on a single supplier: The Company relies on a single supplier, X10
Ltd., as its current sole provider of products and a single supplier, X-10
(USA) as its sole provider of fulfillment and shipping services. (See Note 2.)
A disruption in the supply of these services by the current suppliers could
materially harm the business.
Income taxes: The Company accounts for income taxes under the liability
method in accordance with Statement of Financial Accounting Standards ("SFAS")
No. 109, Accounting for Income Taxes. Under the liability method, deferred tax
assets and liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities and are measured using the
enacted tax rates and laws that will be in effect when the differences are
expected to be recovered. Deferred taxes result from differences between the
financial and tax bases of the Company's assets and liabilities and are
adjusted for changes in tax rates and tax laws when changes are enacted.
Valuation allowances are recorded to reduce deferred tax assets when it is more
likely than not that a tax benefit will not be realized by the Company. Prior
to July 1999, the Company was not a separate taxable entity for federal, state,
or local income tax purposes and its operations were included in the
consolidated X-10 (USA) returns. Accordingly, no tax benefit for the Company's
net operating losses for the period of July 1, 1997 (inception) through July,
1999, has been recognized. (See Note 6.)
Stock-based compensation: The Company accounts for employee and director
stock-based compensation arrangements in accordance with the provisions of
Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued
to Employees, and complies with the disclosure provisions of SFAS No. 123,
Accounting for Stock-Based Compensation. The Company recognizes deferred
compensation expense in accordance with FASB Interpretation No. 28 utilizing
the accelerated method.
Net loss per common share: The Company did not operate as a separate entity
for the period from July 1, 1997 (inception) to September 30, 1999. Therefore,
historical earnings per common share have not been presented in the financial
statements for these periods.
Pro forma net loss per common share (unaudited): Pro forma net loss per
share has been computed in accordance with SFAS No. 128, Earnings per Share,
and Securities and Exchange Commission ("SEC") Staff Accounting Bulletin
("SAB") No. 98 to reflect the pro forma effect of the Company's capitalization
for the entire year of 1999. Under the provisions of SFAS No. 128 and SAB No.
98, basic pro forma net loss per share is computed by dividing the net loss for
the period by the weighted average number of common shares outstanding, using
the pro forma effect of the conversion of the owner's net deficit as if the
shares issued to capitalize the Company had been outstanding over the entire
period for which the pro forma net loss per common share was computed. Common
equivalent shares totalling 1,450,000 related to stock options have
F-9
<PAGE>
X10 WIRELESS TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
been excluded from the calculation because their effect was anti-dilutive. As a
result, basic and diluted net loss per common share were the same.
Segment information: The Company has organized and managed its operations in
a single operating segment as a provider of networking solutions for home and
small businesses. Revenues from customers outside of the United States were
less than 10% of net revenues for all periods presented in the accompanying
statements of operations.
Unaudited interim financial statements: The interim financial information
for the nine months ended September 30, 1999 and 2000, contained herein is
unaudited but, in the opinion of management, reflects all adjustments which are
necessary for a fair presentation of the financial position, results of
operations and cash flows for the periods presented. All such adjustments are
of a normal, recurring nature. Results of operations for interim periods
presented herein are not necessarily indicative of results of operations for
the entire year.
Internally developed software: Effective for fiscal years beginning after
December 15, 1998, the AICPA issued Statement of Position 98-1 ("SOP 98-1"),
Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use. SOP 98-1 requires all costs related to the development of
internal use software other than those incurred during the application
development stage to be expensed as incurred. Costs incurred during the
application development stage are required to be capitalized and amortized over
the estimated useful life of the software. The Company adopted SOP 98-1
beginning January 1, 1999, but has yet to incur significant costs.
Comprehensive income (loss): The Company has no items that would have been
classified as other comprehensive income or loss.
Recent accounting pronouncements: In June 1998, the Financial Accounting
Standards Board ("FASB") issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133, as amended, is effective for
fiscal years beginning after June 15, 2000. SFAS No. 133 requires that all
derivative instruments be recorded on the balance sheet at their fair value.
Changes in the fair value of derivatives are recorded each period in current
earnings or other comprehensive income, depending on whether a derivative is
designated as part of a hedge transaction and, if it is, the type of hedge
transaction. The Company does not expect that the adoption of SFAS No. 133 will
have a material impact on its financial statements because it does not
currently hold any derivative instruments.
In December 1999, the SEC staff released Staff Accounting Bulletin No. 101,
Revenue Recognition in Financial Statements ("SAB No. 101"), which provides
guidance on the recognition, presentation and disclosure of revenue in
financial statements. SAB No. 101 is applicable in the quarter ending December
31, 2000, and is not expected to have a significant impact to the Company.
In October 1999, the SEC identified a list of issues that have arisen in
Internet businesses that the SEC believes should be addressed by the Emerging
Issues Task Force ("EITF") of the FASB or other standard setting bodies. One
such issue is EITF Issue No. 99-19, Reporting Revenue Gross as a Principal
Versus Net as an Agent. This EITF Issue impacts whether revenues are presented
on a gross or net basis in a company's statement of operations. Based on the
Company's understanding of the consensus reached at the July 2000 EITF meeting,
the Company does not believe that EITF Issue No. 99-19 will impact the
Company's presentation of revenues. While the EITF is in the process of
addressing additional issues raised by the SEC, many of the identified issues
have not yet been resolved. Future resolution of the issues identified by the
SEC may affect the Company's financial statements. The Company is not able to
determine the impact on its financial statements, if any, of such future rule-
making.
F-10
<PAGE>
X10 WIRELESS TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
NOTE 2. Formation of the Company
On July 29, 1999, the Company was incorporated in the state of Delaware.
Effective October 1, 1999, X10 Ltd. contributed assets, consisting of the
division of X-10 (USA) making up the business, to the Company. To effect this
contribution of assets, X10 Ltd. and its subsidiaries licensed certain
intellectual property rights and contributed certain assets to the Company in
exchange for the issuance by the Company of 10,000,000 shares of common stock
and the assumption of certain liabilities. At the same time, the Company issued
and sold 10,050,000 shares to the two controlling shareholders of X10 Ltd. in
exchange for notes receivable of $10,050, which were paid in May 2000. The
assets and liabilities of the business contributed to the Company were
accounted for at X10 Ltd.'s historical cost since there was no change in
control over the contributed business.
Agreements entered into with X10 Ltd. and its direct and indirect
subsidiaries are as follows:
Amended and Restated Bill of Sale and Assignment. Effective October 1, 1999,
the Company entered into an amended and restated bill of sale and assignment
under which X10 Ltd. sold and assigned to the Company the technology and
intellectual property relating to the Company's broadband wireless products as
partial consideration for the issuance of 10,000,000 shares of the Company's
common stock to X10 Ltd.
Amended and Restated License Agreement. Effective October 1, 1999, the
Company entered into an Amended and Restated License Agreement under which X10
Ltd. has granted to the Company a perpetual right to use, design, develop,
manufacture, market, sell and distribute all existing and future electrical
products owned by X10 Ltd. The agreement provides that these rights are
exclusive to the Company, on a worldwide basis, except for sales of non-branded
products by X10 Ltd. to original equipment manufacturers and sellers of
customized, bundled or private-label products. The Company also received the
exclusive, perpetual right, on a worldwide basis, to use the copyrights, trade
names, trade dress, trademarks and service marks owned by X10 Ltd. related to
the "X10" mark, in the marketing, sale and distribution of the Company's
products and the products subject to the license. The license expires on
December 31, 2019, unless renewed for subsequent five-year terms at the
Company's option.
Product Supply Relationship. Effective October 1, 1999, the Company entered
into an Amended and Restated Product Supply Agreement under which X10 Ltd. has
agreed to manufacture, at the Company's direction, broadband wireless and
phoneline, infared and electrical products, and to ship the products on
consignment to a warehouse designated by the Company, currently X-10 (USA). The
Company is obligated to purchase the products on the earlier of receipt of a
purchase order from a customer or 120 days from delivery of the products by X10
Ltd. to the shipper. Under the agreement, the Company pays X10 Ltd. a fee for
the products equal to X10 Ltd.'s costs to produce the products. In the event of
a breach or default by X10 Ltd. under this agreement, the Company has a
contractual right to setoff any amounts owed by us against any losses resulting
from the breach or default. This agreement expires on December 31, 2019, unless
renewed for subsequent five-year terms at the Company's option. Product payment
is due 30 days from receipt of invoice, but no earlier than the date of
shipment to the Company's customer.
Research and Development Relationship. Effective October 1, 1999, the
Company entered into an Amended and Restated Research and Development Services
Agreement with X10 Ltd. under which X10 Ltd. has agreed, at the Company's
direction, to conduct research and development for the design and production of
the Company's wireless products; to submit estimates of costs required to
develop prototypes and manufacture the products; to determine all necessary or
appropriate production standards and licensing requirements; and to provide
specifications for and produce workable prototypes. Under the agreement, the
Company pays a service fee in connection with the development of each product
as established by X10 Ltd. This agreement expires on December 31, 2019, unless
renewed for subsequent five-year terms at the Company's option. From the
Company's inception through December 31, 1999, the Company did not incur any
fees related to research and
F-11
<PAGE>
X10 WIRELESS TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
development services. During the nine-month period ended September 30, 2000,
the Company incurred total fees of $450,000.
Contract Manufacturing Agreement. Effective April 1, 2000, the Company
entered into a Contract Manufacturing Agreement with X10 Ltd. under which X10
Ltd. will pay to the Company a variable fee based on X10 Ltd.'s sales of the
Company's wireless products and, where the Company has provided the
introduction, sales of electrical products to original equipment manufacturers
and other resellers that sell customized, bundled or private-label versions of
the products the Company offers. Under this Agreement, the Company's fee is
equal to the net sales price of the products sold by X10 Ltd., less costs and a
manufacturing fee retained by X10 Ltd. This manufacturing fee is equal to 15%
of the net sales price of each product sold until aggregate sales of that
product reach $2,000,000 and 10% of the net sales price of each product
thereafter. X10 Ltd. is required to sell the products on the same terms and
conditions that the Company has previously negotiated. In addition, the Company
has the right to sell products directly to OEM customers, in which the Company
pays a fee to X10 Ltd. equal to the actual costs of manufacturing and shipping
the products. This agreement expires April 1, 2005, and will automatically be
renewed for subsequent five-year terms unless terminated by either party.
Amended and Restated Asset Purchase Agreement. Effective October 1, 1999,
the Company entered into an Amended and Restated Asset Purchase Agreement with
X-10 (USA) under which X-10 (USA) transferred to the Company all right and
title to specified universal resource locators, or URLs, domain names and
website names, as well as all customer, vendor and supplier lists, and sales,
product and promotional literature or aids used in connection with those
assets. In exchange, the Company issued a promissory note to X-10 (USA) in the
principal amount of $1,024,300, which was subsequently assigned to X10 Ltd. The
note was canceled in partial consideration of the Company's issuance to X10
Ltd. of 10,000,000 shares of the Company's common stock. The Company also
assumed approximately $1,183,000 of specific liabilities of X-10 (USA), related
to the assets acquired, in consideration of which X-10 (USA) has issued to the
Company a promissory note in the principal amount of approximately $1,183,000.
As of September 30, 2000, this promissory note was paid in full.
Fulfillment Services Relationship. Effective October 1, 1999, the Company
entered into an Amended and Restated Fulfillment Services Agreement with X-10
(USA), under which X-10 (USA) has agreed to warehouse and ship products
manufactured for the Company by X10 Ltd. and other manufacturers. Under the
agreement, X-10 (USA) ships products to the Company's customers in accordance
with fulfillment orders that the Company submits to X-10 (USA) from time to
time. The Company pays a fee in connection with these services equal to 10% of
the Company's gross receipts for the products shipped, excluding sales and
other taxes. This agreement expires December 31, 2004, unless renewed for
subsequent five-year terms at the Company's option. The fee is due 30 days from
receipt of the invoice from X-10 (USA).
Amended and Restated Sublicense Agreement. Effective October 1, 1999, the
Company entered into an Amended and Restated Sublicense Agreement with X-10
(USA), under which the Company granted X-10 (USA) a non-exclusive sublicense to
market, sell and distribute in the western hemisphere electrical products
licensed to the Company by X10 Ltd., as well as any new products the Company
may select. The sublicense is limited to sales of X10-branded products to
resellers, other than original equipment manufacturers and resellers of
customized, bundled or private-label products. Under the agreement, X-10 (USA)
pays the Company a quarterly license fee of 15% of its net sales of licensed
products, or a minimum license fee, whichever is greater. The minimum license
fee is $250,000 per quarter during the first year of the term, $500,000 per
quarter during the second year of the term and $750,000 per quarter during the
third year of the term. Thereafter, there is no minimum license fee. The
sublicense expires on December 31, 2004, and will be automatically renewed for
subsequent five-year terms unless terminated by either party.
F-12
<PAGE>
X10 WIRELESS TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Administrative Services Arrangement. Effective October 1, 1999, the Company
entered into an Administrative Services Agreement with Orca Monitoring
Services, L.L.C. ("Orca"), a wholly owned subsidiary of X10 Ltd., under which
Orca provides to the Company telephone reception services, customer service and
technical support after the Company's normal business hours, as well as general
office administration and support. The agreement expires October 1, 2000, and
will be automatically renewed for subsequent one-year terms unless terminated
by mutual agreement of the parties. The Company pays a service fee based upon
head count, actual usage and allocation of floor space. The fee is due 30 days
from receipt of the invoice from Orca.
NOTE 3. Related Party Transactions.
Allocated costs: As discussed in Note 1, the financial statements of the
Company reflect certain allocated corporate support costs from X10 Ltd. and X-
10 (USA). Such allocations and charges are based on a percentage of total
corporate costs for the services provided, based on factors such as revenue and
specific level of activity directly related to such costs.
Management believes that the allocation methods used are reasonable and
reflective of the Company's proportionate share of such expenses and are not
materially different from those that would have been incurred on a stand-alone
basis.
F-13
<PAGE>
X10 WIRELESS TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The following is a summary of transactions with related parties (dollars in
thousands):
<TABLE>
<CAPTION>
July 1, 1997 Nine Months
(inception) Year Ended Ended
to December 31, September 30,
December 31, ------------- -------------
1997 1998 1999 1999 2000
------------ ------ ------ ------ ------
(unaudited)
<S> <C> <C> <C> <C> <C>
Revenue earned under agreements
effective October 1, 1999:
License fees........................ $ -- $ -- $ 261 $ -- $ 776
Fees from sales of customized,
bundled or private-label products.. -- -- -- -- 1,222
Allocated expenses included in:
Cost of revenues.................... 56 1,143 5,187 5,187 --
Research and development............ 1 24 314 314 --
Sales and marketing................. 43 553 2,343 2,343 --
General and administrative.......... 149 575 1,167 1,167 --
Expenses incurred under agreements
effective October 1, 1999:
Cost of revenues.................... -- -- 3,793 -- 12,907
Research and development............ -- -- 85 -- 784
Sales and marketing................. -- -- 1,188 -- 3,266
General and administrative.......... -- -- 569 -- 640
Contribution of net liabilities
October 1, 1999...................... -- -- 1,183 -- --
Capital contributions................. 345 998 3,073 3,073 722
</TABLE>
<TABLE>
<CAPTION>
December 31
------------ September 30,
1998 1999 2000
---- ------- -------------
(unaudited)
<S> <C> <C> <C>
Amounts due (to) from related parties:
Due to X10 Ltd.................................... $ $(1,979) $(6,527)
Due (to) from X-10 (USA).......................... -- 691 (246)
Due (to) from Orca................................ 715 114 (25)
---- ------- -------
Total amounts due (to) from related parties..... $715 $(1,174) $(6,798)
==== ======= =======
</TABLE>
NOTE 4. Employee Benefit Plans
1999 Stock Plan: Effective October 1, 1999, the Company's Board of Directors
adopted the 1999 Stock Plan (the "Plan"), which provides that the Board of
Directors may grant incentive stock options or nonqualified stock options to
employees, directors and consultants. Stock purchase rights may also be granted
under the Plan. The maximum aggregate number of shares subject to option under
the Plan is 3,500,000 shares of common stock. Options generally become
exercisable within a five-year period. Options generally expire ten
years from the date of grant. On October 1, 1999, the Board of Directors
granted options to acquire 1,450,000 shares, all of which were outstanding as
of December 31, 1999 and September 30, 2000, and there were 2,050,000 shares
available in the Plan as of December 31, 1999 and September 30, 2000 for future
awards.
F-14
<PAGE>
X10 WIRELESS TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
A summary of stock option activity follows (share amounts in thousands):
<TABLE>
<CAPTION>
Year Ended Nine Months
December 31, Ended September
1999 30, 2000
--------------- ---------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
------ -------- ------ --------
(unaudited)
<S> <C> <C> <C> <C>
Outstanding, beginning....................... -- $ -- 1,450 $0.001
Options issued............................. 1,450 0.001 240 9.80
Options exercised.......................... -- -- -- --
Options cancelled.......................... -- -- -- --
----- -----
Outstanding, ending.......................... 1,450 $0.001 1,690 $ 1.39
===== =====
</TABLE>
<TABLE>
<CAPTION>
Year Ended Nine Months Ended
December 31, 1999 September 30, 2000
------------------------ ------------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Exercise Fair Exercise Fair
Shares Price Value Shares Price Value
------ -------- -------- ------ -------- --------
(unaudited)
<S> <C> <C> <C> <C> <C> <C>
Exercise price exceeds
market price............ -- $ -- $ -- -- $ -- $ --
Exercise price equals
market price............ -- -- -- -- -- --
Exercise price is less
than market price....... 1,450 $0.001 $2.49 1,690 $1.39 $4.12
</TABLE>
All of the options granted in October 1999 vest at a rate of 12.5% of the
shares subject to the option every six months and expire in October 2009.
Fair value disclosures: Under SFAS No. 123, employee stock options are
valued at the grant date using the Black-Scholes valuation model with the
following assumptions for options granted on October 1, 1999: risk-free
interest rate at 6.0%; expected dividend yield of 0%; no volatility; and an
expected life of four years. Related compensation expense is being recognized
ratably over the vesting period. The weighted average fair value of options
granted during 1999 was $2.49 per share. Compensation expense calculated under
SFAS No. 123 is the same as the amount recognized by the Company under APB
Opinion No. 25.
NOTE 5. Commitments and Contingencies
The Company is subject to various claims which arise in the normal course of
business. In the opinion of management, the ultimate disposition of these
claims will not have a material effect on the financial statements of the
Company.
Under the terms of the Amended and Restated Product Supply Agreement, the
Company is obligated to purchase product 120 days from delivery of the product
by X10 Ltd. to the shipper. The Company's maximum purchase obligation would be
X10 Ltd.'s inventory held by the shipper. As of September 30, 2000, X10 Ltd.'s
inventory at the shipper location was approximately $5.7 million (unaudited).
The shipper has held none of this inventory greater than 120 days.
NOTE 6. Income Taxes
No provision for income taxes has been recorded because the Company has
incurred net losses since its inception and the Company received no benefit for
such losses from the consolidated X10 Ltd. group prior to the Company's
inception.
F-15
<PAGE>
X10 WIRELESS TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The effective tax rate differs from the federal statutory rate as follows:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
December 31, September 30,
1999 2000
------------ -------------
(unaudited)
<S> <C> <C>
Tax benefit at statutory rate..................... (34.0)% (34.0)%
Other............................................. -- 0.1
Change in valuation allowance..................... 34.0 33.9
----- -----
0.0 % 0.0 %
===== =====
</TABLE>
Management believes that, based on a number of factors, the available
objective evidence creates sufficient uncertainty regarding the realizability
of the deferred tax asset such that a full valuation allowance has been
recorded.
Deferred tax assets were comprised of the following (in thousands):
<TABLE>
<CAPTION>
December 31, September 30,
1999 2000
------------ -------------
(unaudited)
<S> <C> <C>
Net operating loss carryforwards.................. $ 678 $ 1,177
Other............................................. 645 2,896
------- -------
Gross deferred tax assets......................... 1,323 4,073
Less: valuation allowance......................... (1,323) (4,073)
------- -------
Net deferred tax asset............................ $ -- $ --
======= =======
</TABLE>
The Company generated operating loss carryforwards totalling $1.9 million
and $8.5 million (unaudited) as of December 31, 1999, and September 30, 2000,
respectively. These carryforwards may be used to offset future federal taxable
income and will expire beginning in 2019.
NOTE 7. Subsequent Events
In July 2000, the Company terminated the 1999 Stock Plan, effective as of,
and contingent upon, the effective date of the Company's registration statement
related to an initial public offering of the Company's common stock and adopted
the 2000 Equity Incentive Plan and Employee Stock Purchase Plan.
These plans provide that the Board of Directors may grant incentive stock
options, nonstatutory stock options, restricted stock purchase rights and stock
bonuses to employees, directors and consultants.
In July and October 2000, the Company approved the issuance of options to
purchase an aggregate of 240,000 shares of common stock to be granted to non-
employee Board members at an exercise price of 70% of the initial public
offering price. The compensation expense relating to these options is variable
until the measurement date occurs. Deferred compensation of approximately
$1.0 million, when measured, will be amortized over the two-year vesting period
of these options.
NOTE 8. Restatement
Subsequent to the issuance of the Company's financial statements as of and
for the year ended December 31, 1999, the Company's management determined that
the fair value of the Company's common stock for accounting purposes used to
measure compensation expense related to stock options granted to employees and
directors,
F-16
<PAGE>
X10 WIRELESS TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
should be $2.49 per share rather than $0.40 per share. In addition, the shares
of the Company's common stock sold by the Company's chief executive officer and
chairman of the board to three of the Company's employees on October 1, 1999,
for less than fair value per share on that date should be recognized as
compensation expense.
The Company's financial statements as of and for the year ended December 31,
1999, have been restated from the amounts previously reported to recognize
additional non-cash stock-based compensation expense of $1.8 million and
unearned compensation of $2.6 million based upon the fair value of the
Company's common stock. Additional paid-in capital has also been increased by
$4.4 million. A summary of the significant effects of the restatement is as
follows:
<TABLE>
<CAPTION>
As previously As
reported restated
------------- --------
(in thousands, except
per share amounts)
<S> <C> <C>
For the year ended December 31, 1999:
Non-cash stock-based compensation..................... 76 1,829
Net loss.............................................. (5,596) (7,349)
Pro forma basic and diluted net loss per common
share................................................ $ (.28) $ (.37)
At December 31, 1999:
Unearned compensation................................. $ (504) $(3,139)
Additional paid-in capital............................ 671 5,059
Retained earnings (deficit)........................... (2,140) (3,893)
</TABLE>
F-17
<PAGE>
DESCRIPTION OF INSIDE BACK COVER OF PROSPECTUS:
Top: In the left corner is the X10 Wireless Technology, Inc. logo. The inside
back cover is entitled "Local and Remote Access & Control" and has four sections
showing pictures of different product categories we offer.
Under the heading "Wireless Camera Broadcasting," are images of an X10 wireless
camera and video sender device together with the words "Xcam2/TM/ Camera" and
"X10 Video Sender/TM/."
Under the heading "Security Products," are images of an X10 motion sensor device
above the words "EagleEye Motion Sensor/TM/," an X10 wireless camera below the
words "Xcam2/TM/ Camera," and images of the products included in the X10
Protector Plus Kit with the words "Protector Plus/TM/."
Under the heading "Automation Products," are images of X10 home and small office
automation products together with the words "ActiveHome/TM/," "Slimline
Switch/TM/," "SlimFire/TM/," and "PalmPad/TM/."
Under the heading "Lighting and Electrical Device Control Modules," are images
of X10 lighting and electrical device control modules together with the words
"Control Module," "Socket Rocket/TM/," and "Outdoor Motion Monitor/TM/."
<PAGE>
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
5,000,000 Shares
[LOGO OF X10]
X10 Wireless
Technology, Inc.
Common Stock
---------------------------
PRELIMINARY PROSPECTUS
---------------------------
Bear, Stearns & Co. Inc.
Prudential Volpe Technology
a unit of Prudential Securities
C.E. Unterberg, Towbin
, 2000
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. Other Expenses of Issuance and Distribution
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by us in connection with the
sale of common stock being registered.
<TABLE>
<S> <C>
SEC Registration fee............................................. $ 24,288
NASD fee......................................................... 9,700
Nasdaq National Market initial listing fee....................... 95,000
Printing and engraving........................................... 200,000
Legal fees and expenses.......................................... 1,000,000
Accounting fees and expenses..................................... 250,000
Blue sky fees and expenses....................................... 10,000
Transfer agent fees.............................................. 3,600
Directors' and officers' Securities Act liability insurance...... 320,000
Miscellaneous.................................................... 87,412
----------
Total.......................................................... $2,000,000
==========
</TABLE>
----------
* To be provided by amendment.
ITEM 14. Indemnification of Directors and Officers
Section 145 of the Delaware General Corporation Law authorizes a court to
award or a corporation's board of directors to provide indemnification to
directors and officers in terms sufficiently broad to permit such
indemnification under certain circumstances for liabilities (including
reimbursement for expenses incurred) arising under the Securities Act. In
addition, our by-laws provide for mandatory indemnification of our directors
and executive officers and permit indemnification of employees and other agents
to the maximum extent permitted by the Delaware General Corporation Law.
We intend to enter into certain indemnity agreements with our directors and
certain of our officers, the form of which is attached as Exhibit 10.1 to this
registration statement. These indemnity agreements will provide our directors
and certain of our officers with indemnification to the maximum extent
permitted by the Delaware General Corporation Law.
The underwriting agreement (Exhibit 1.1 hereto) provides for indemnification
by the underwriters of us and of our executive officers and directors, and by
us of the underwriters, for certain liabilities, including liabilities arising
under the Securities Act, in connection with specified matters.
ITEM 15. Recent Sales of Unregistered Securities
Since our inception, we have issued unregistered securities to a limited
number of persons, as described below. Since October 1, 1999, we have issued
and sold the following unregistered securities:
(1) In October 1999, we issued 5,050,000 shares of common stock to George
Stevenson at an aggregate purchase price of $5,050, or $0.001 per
share. Also in October 1999, Mr. Stevenson made gifts of or sold
2,050,000 of these shares to 10 individuals residing in the U.S. and
foreign countries.
(2) In October 1999, we issued 5,000,000 shares of common stock to Hin
Chew Chung for an aggregate purchase price of $5,000, or $0.001 per
share. Also in October 1999, Mr. Chung made gifts of 2,000,000 of
these shares to 25 individuals all residing outside the U.S.
II-1
<PAGE>
(3) In October 1999, we issued an aggregate of 10,000,000 shares of common
stock to X10 Ltd. in consideration of the assignment to us of
intellectual property, execution and delivery of an Amended and
Restated Bill of Sale and Assignment, Amended and Restated License
Agreement and Amended and Restated Product Supply Agreement, and in
full repayment of a promissory note in the principal amount of
$1,024,300 that we issued to X-10 (USA) and that X-10 (USA)
subsequently assigned to X10 Ltd.
(4) In October 1999, we issued stock options under our 1999 Stock Plan to
our employees and consultants to purchase an aggregate of 1,450,000
shares of common stock with an aggregate exercise price of $1,450, or
$0.001 per share.
(5) In July and October 2000, our board of directors authorized the grant
of stock options to our non-employee directors to purchase an
aggregate of 240,000 shares of common stock, at a per share price
equal to 70% of the initial public offering price.
With reference to paragraphs (1) and (2) above, we claimed exemption from
registration for the shares issued to and retained by Mr. Stevenson and Mr.
Chung in reliance on section 4(2) of the Securities Act. We claimed exemption
from registration for shares acquired by the other persons referenced in
paragraphs (1) and (2) above in reliance on section 4(2) of the Securities Act
and Regulation S under the Securities Act. We claimed exemption from
registration for the issuance described in paragraph (3) above in reliance upon
section 4(2) of the Securities Act. We claimed exemption from registration for
the issuances described in paragraphs (4) and (5) above in reliance on Rule 701
under the Securities Act on the basis that they were issued pursuant to written
compensatory benefit plans as provided in Rule 701. In addition, with respect
to the issuances described in paragraphs (4) and (5) above, we claimed that
registration under the Securities Act was not required on the basis that none
of these grants involved a "sale" of securities as defined in section 2(a)(3)
of the Securities Act.
The recipients of securities in each transaction for which exemption was
claimed under section 4(2) of the Securities Act represented their intentions
to acquire the securities for investment only and not with a view to or for
public distribution and appropriate legends were affixed to the securities
issued in such transactions. All recipients had adequate access to information
about us, through their relationships with us. The recipients of securities in
each transaction for which exemption was claimed in reliance on Regulation S
under the Securities Act represented that they were not "U.S. Persons," as
defined in Regulation S, and that they were acquiring the shares for investment
purposes only and not with a view to or for public distribution in the U.S. or
elsewhere. In addition, appropriate legends were affixed to the securities
issued in reliance on Regulation S and we agreed not to register any transfer
of these securities not made in accordance with the provisions of Regulation S,
pursuant to registration under the Securities Act or pursuant to an available
exemption from registration.
ITEM 16. Exhibits and Financial Statement Schedules
(a) Exhibits
<TABLE>
<C> <S>
1.1 Form of Underwriting Agreement
3.1+ Amended and Restated Certificate of Incorporation, as currently in
effect
3.2+ Form of Amended and Restated Certificate of Incorporation, to be
effective upon completion of this offering
3.3+ Bylaws, as amended and currently in effect
3.4+ Form of Amended and Restated Bylaws, to be effective upon completion of
this offering
4.1 Specimen Common Stock Certificate
5.1* Opinion of Cooley Godward LLP
10.1+ Form of Indemnity Agreement between the Company and each of its
directors and certain of its officers
10.2+ 1999 Stock Plan
</TABLE>
II-2
<PAGE>
<TABLE>
<C> <S>
10.3+ Form of Stock Option Agreement under the 1999 Stock Plan
10.4+ 2000 Equity Incentive Plan
10.5+ Form of Stock Option Agreement under the 2000 Equity Incentive Plan
10.6+ 2000 Employee Stock Purchase Plan
10.7+ Form of 2000 Employee Stock Purchase Plan Offering
10.8+ Amended and Restated Asset Purchase Agreement, effective October 1,
1999, between the Company and X-10 (USA) Inc.
10.9+ Amended and Restated Bill of Sale and Assignment, effective October 1,
1999, between the Company and X10 Ltd.
10.10+ Amended and Restated License Agreement, effective October 1, 1999,
between the Company and X10 Ltd.
10.11+ Amended and Restated Sublicense Agreement, effective October 1, 1999,
between the Company and X-10 (USA) Inc.
10.12+ Amended and Restated Product Supply Agreement, effective October 1,
1999, between the Company and X10 Ltd.
10.13+ Amended and Restated Fulfillment Services Agreement, effective October
1, 1999, between the Company and X-10 (USA) Inc.
10.14+ Amended and Restated Research and Development Services Agreement,
effective October 1, 1999, between the Company and X10 Ltd.
10.15+ Contract Manufacturing Agreement, effective April 1, 2000, between the
Company and X10 Ltd.
10.16+ Administrative Services Agreement, effective October 1, 1999, between
the Company and Orca Monitoring Services, L.L.C.
10.17+ Form of Subscription Agreement, effective October 1, 1999, between the
Company and each of Hin Chew Chung and George E. Stevenson
10.18+ Amended and Restated Subscription Agreement, effective October 1, 1999,
between the Company and X10 Ltd.
23.1 Consent of Deloitte & Touche LLP
23.2* Consent of Cooley Godward LLP (included in Exhibit 5.1)
24.1 Power of Attorney (contained on signature page)
27.1 Financial Data Schedule
</TABLE>
----------
+ Previously filed.
* To be supplied by amendment.
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the
consolidated financial statements or notes thereto.
II-3
<PAGE>
ITEM 17. Undertakings
We hereby undertake to provide to the underwriters at the closing specified
in the Underwriting Agreement, certificates in the denominations and registered
in the names as required by the underwriters to permit prompt delivery to each
purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of X10
Wireless Technology pursuant to the provisions referenced in Item 14 of this
registration statement or otherwise, X10 Wireless Technology has been advised
that in the opinion of the SEC this indemnification is against public policy as
expressed in the Securities Act and is, therefore, unenforceable. In the event
that a claim for indemnification against these liabilities (other than the
payment by X10 Wireless Technology of expenses incurred or paid by a director,
officer, or controlling person of X10 Wireless Technology in the successful
defense of any action, suit or proceeding) is asserted by a director, officer
or controlling person in connection with the securities being registered
hereunder, X10 Wireless Technology will, unless in the opinion of its counsel
the matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question of whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed
by the final adjudication of such issue.
X10 Wireless Technology hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form
of prospectus filed by X10 Wireless Technology pursuant to Rule 424(b)(1)
or (4) or 497(h) under the Securities Act will be deemed to be part of this
Registration Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new Registration Statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, X10
Wireless Technology, Inc. has duly caused this amendment no. 2 to the
registration statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Seattle, State of Washington, on the 27th day
of November, 2000.
X10 Wireless Technology, Inc.
/s/ Wade A. Pfeiffer
By: ________________________________
Wade A. Pfeiffer
Chief Financial Officer
Pursuant to the requirements of the Securities Act of 1933, as amended, this
amendment no. 2 to the registration statement has been signed by the following
persons in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
* Chairman of the Board and November 27, 2000
______________________________________ Chief Executive Officer
George E. Stevenson (Principal Executive
Officer)
/s/ Wade A. Pfeiffer Chief Financial Officer November 27, 2000
______________________________________ (Principal Financial and
Wade A. Pfeiffer Accounting Officer)
* Director November 27, 2000
______________________________________
C. Gregory Amadon
* Director November 27, 2000
______________________________________
William T. Baxter
* Director November 27, 2000
______________________________________
Hin Chew Chung
* Director November 27, 2000
______________________________________
Alexander E. Peder
* Director November 27, 2000
______________________________________
James R.W. Phillips
</TABLE>
/s/ Wade A. Pfeiffer
*By: ________________________________
Wade A. Pfeiffer
Attorney-in-Fact
II-5
<PAGE>
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that the individual whose signature
appears below constitutes and appoints George E. Stevenson and Wade A.
Pfeiffer, his true and lawful attorney-in-fact and agents each acting alone,
with full power of substitution and resubstitution, for him and in his name,
place and stead in any and all capacities to sign any or all amendments
(including post-effective amendments) to this registration statement, and any
registration statement filed pursuant to Rule 462(b) under the Securities Act
of 1933 in connection with the registration under the Securities Act of 1933 of
equity securities of X10 Wireless Technology, Inc. and to file the same with
all exhibits thereto, and other documents in connection therewith, with the
SEC, granting unto said attorneys-in-fact and agents full power and authority
to do and perform each and every act and thing requisite and necessary to be
done in and about the premises, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact, or their substitutes, each acting alone, may lawfully do or
cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, as amended, this
amendment no. 2 to the registration statement has been signed by the following
person in the capacity and on the date indicated:
<TABLE>
<S> <C> <C>
/s/ Bernard S. Appel Director November 27, 2000
______________________________________
Bernard S. Appel
</TABLE>
II-6
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<C> <S>
1.1 Form of Underwriting Agreement
3.1+ Amended and Restated Certificate of Incorporation, as currently in
effect
3.2+ Form of Amended and Restated Certificate of Incorporation, to be
effective upon completion of this offering
3.3+ Bylaws, as amended and currently in effect
3.4+ Form of Amended and Restated Bylaws, to be effective upon completion of
this offering
4.1 Specimen Common Stock Certificate
5.1* Opinion of Cooley Godward LLP
10.1+ Form of Indemnity Agreement between the Company and each of its
directors and certain of its officers
10.2+ 1999 Stock Plan
10.3+ Form of Stock Option Agreement under the 1999 Stock Plan
10.4+ 2000 Equity Incentive Plan
10.5+ Form of Stock Option Agreement under the 2000 Equity Incentive Plan
10.6+ 2000 Employee Stock Purchase Plan
10.7+ Form of 2000 Employee Stock Purchase Plan Offering
10.8+ Amended and Restated Asset Purchase Agreement, effective October 1,
1999, between the Company and X-10 (USA) Inc.
10.9+ Amended and Restated Bill of Sale and Assignment, effective October 1,
1999, between the Company and X10 Ltd.
10.10+ Amended and Restated License Agreement, effective October 1, 1999,
between the Company and X10 Ltd.
10.11+ Amended and Restated Sublicense Agreement, effective October 1, 1999,
between the Company and X-10 (USA) Inc.
10.12+ Amended and Restated Product Supply Agreement, effective October 1,
1999, between the Company and X10 Ltd.
10.13+ Amended and Restated Fulfillment Services Agreement, effective
October 1, 1999, between the Company and X-10 (USA) Inc.
10.14+ Amended and Restated Research and Development Services Agreement,
effective October 1, 1999, between the Company and X10 Ltd.
10.15+ Contract Manufacturing Agreement, effective April 1, 2000, between the
Company and X10 Ltd.
10.16+ Administrative Services Agreement, effective October 1, 1999, between
the Company and Orca Monitoring Services, L.L.C.
10.17+ Form of Subscription Agreement, effective October 1, 1999, between the
Company and each of Hin Chew Chung and George E. Stevenson
10.18+ Amended and Restated Subscription Agreement, effective October 1, 1999,
between the Company and X10 Ltd.
23.1 Consent of Deloitte & Touche LLP
23.2* Consent of Cooley Godward LLP (included in Exhibit 5.1)
24.1 Power of Attorney (contained on signature page)
27.1 Financial Data Schedule
</TABLE>
----------
+ Previously filed.
* To be supplied by amendment.
